What a certificate of deposit is and how you earn money from it

A certificate of deposit (CD) is an account where you give a bank a lump sum of money for a fixed period—typically three months to five years—and the bank pays you a set interest rate on that money. You cannot withdraw the funds before the term ends without paying a penalty. In exchange for locking up your money, the bank offers you a higher interest rate than you would get in a regular savings account.

The money you deposit earns interest at a rate the bank promises when you open the CD. That rate stays the same for the entire term, no matter what happens to interest rates in the market. When the CD matures (reaches the end of its term), you get back your original deposit plus all the interest you earned.

CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per bank. This means if the bank fails, your money is protected up to that limit.

Key Takeaways

  • You deposit a fixed amount of money for a set term (three months to five years), and the bank locks in an interest rate for that entire period.
  • You cannot withdraw your money before the term ends without paying an early withdrawal penalty, which typically costs several months of interest.
  • Interest rates on CDs are higher than savings accounts because you are giving up access to your money for a defined time.
  • When your CD matures, you receive your original deposit plus all accrued interest, and you can then choose to cash out, renew, or open a new CD.
  • FDIC insurance protects your deposit up to $250,000 if the bank fails.

How the interest rate and term length work together

The interest rate a bank offers on a CD depends on two things: the current market rate for CDs and the length of the term you choose. Longer terms usually come with higher rates because you are committing your money for a longer time. A five-year CD might pay 4.5%, while a three-month CD might pay 3.8%.

The bank calculates your interest based on the rate and term you agreed to when you opened the account. Some banks compound interest daily, others monthly or quarterly—the more frequent the compounding, the slightly more interest you earn. The bank will tell you the annual percentage yield (APY), which shows you the total return you will receive over one year, accounting for how often interest is compounded.

Once you lock in a rate, it does not change. If market rates rise after you open your CD, you still earn the rate you agreed to. If rates fall, you still earn that same rate—which is why longer-term CDs lock in higher rates to compensate you for the risk that rates might drop.

What happens if you need your money before the term ends

If you withdraw money from a CD before the maturity date, the bank charges an early withdrawal penalty. This penalty varies by bank and by CD term. For a short-term CD (three to six months), the penalty might be one month of interest. For a longer-term CD (two to five years), the penalty could be three to six months of interest or a flat fee.

The penalty comes out of your interest earnings first. If you have earned less interest than the penalty costs, the bank takes the difference from your principal. For example, if you earned $200 in interest but the penalty is $300, you lose the $200 in interest plus $100 of your original deposit.

Before you open a CD, ask the bank what the early withdrawal penalty is. Some banks offer no-penalty CDs that let you withdraw your money early without a fee, though these typically pay lower interest rates than traditional CDs.

When your CD matures and what your options are

When your CD reaches its maturity date, the bank sends you a notice (usually 10 to 30 days before the date). At that point, you have three choices: cash out and take your money, renew the CD for another term at the current rate, or move the money to a different account.

If you do nothing, many banks automatically renew your CD into a new term of the same length at whatever the current rate is. This can work in your favor if rates have risen, but it locks you in again if you were planning to access the money. Check your CD agreement to see what your bank's auto-renewal policy is, and set a calendar reminder so you do not miss the maturity date.

When the CD matures and you receive your money, the interest you earned is taxable income in the year you receive it. The bank will send you a Form 1099-INT showing how much interest you earned, which you report on your tax return.

CDs versus savings accounts and money market accounts

A CD pays more interest than a regular savings account because you give up access to your money. A savings account lets you withdraw anytime without penalty, but the interest rate is lower—often less than half what a CD pays. If you need quick access to your money, a savings account is the right choice. If you have money you will not need for several months or years, a CD usually pays better.

A money market account sits between the two. It typically pays more than a savings account but less than a CD, and it gives you limited withdrawal rights—usually three to six withdrawals per month. Money market accounts are useful if you want higher interest than savings but need more flexibility than a CD offers.

The choice depends on when you will need the money. If you have an emergency fund, keep it in a savings account. If you have money set aside for a goal one to five years away, a CD locks in a may provide rate. If you want something in between, consider a money market account.

How to open a CD and what information you need

To open a CD, you go to a bank or credit union and tell them the amount you want to deposit and the term length you want. You can open a CD in person, online, or by phone. You will need to provide your name, address, Social Security number, and identification. If you are opening it at a bank where you already have an account, the process is faster.

The bank will show you the current rate for each term length and ask you to choose. Once you agree, the bank deducts the deposit from your checking or savings account (or you can bring a check or wire the money). The CD is then active, and interest starts accruing immediately.

You receive a CD agreement that shows the deposit amount, the interest rate, the maturity date, the compounding frequency, and the early withdrawal penalty. Keep this document. You will need it if you have questions later or if you want to withdraw early.

Shopping for the best CD rate

CD rates change daily based on what the Federal Reserve does and what other banks are offering. A rate that is competitive today might not be next week. Before you open a CD, compare rates across multiple banks—online banks often pay higher rates than brick-and-mortar banks because they have lower overhead costs.

Look at the APY, not just the interest rate, because APY accounts for how often interest is compounded. A CD that compounds daily will pay slightly more than one that compounds monthly, even at the same stated rate. Also check the minimum deposit required—some banks require $500 or $1,000 to open a CD, while others have no minimum.

If you have a large amount to deposit, ask whether the bank offers CD laddering—opening multiple CDs with different maturity dates so that some mature each year. This gives you regular access to portions of your money while keeping the rest locked in at higher rates.

Frequently Asked Questions

Can I add money to a CD after I open it?

No. A CD is a fixed deposit—you choose the amount when you open it, and you cannot add more money to that same CD. If you want to deposit additional funds, you must open a separate CD. Some banks let you open multiple CDs at the same time with different amounts.

What if the bank fails while my CD is open?

The FDIC insures your deposit up to $250,000. If the bank fails, the FDIC pays you your full deposit plus all accrued interest up to that limit. Your CD does not disappear—you simply receive your money from the insurance fund instead of the bank.

Do I pay taxes on CD interest?

Yes. The interest you earn on a CD is taxable income. The bank sends you a Form 1099-INT showing the interest amount, which you report on your tax return for the year you receive the money. If you withdraw early and lose some interest to the penalty, you still pay taxes only on the interest you actually earned.

Can I move a CD to a different bank?

You can withdraw your CD when it matures and deposit the money at another bank, but you cannot transfer an active CD to a different bank mid-term without paying the early withdrawal penalty. When your CD matures, you are free to move the money anywhere without penalty.

What is the difference between a CD and a bond?

A CD is a bank product insured by the FDIC; a bond is a debt security issued by a company or government. CDs have fixed terms and may provide returns. Bonds can be bought and sold on the market, and their value changes based on interest rates and the issuer's creditworthiness. CDs are simpler and safer for most people.