A CD is a savings account where you lock up your money for a set time in exchange for a higher interest rate
A certificate of deposit (CD) is an agreement between you and a bank. You give the bank a sum of money—anywhere from $500 to $100,000 or more, depending on the bank—and promise not to touch it for a fixed period. In return, the bank pays you interest at a rate higher than you'd get from a regular savings account. When the time is up, you get your original money back plus the interest earned.
The bank uses your money during that locked period to make loans and investments. That's why they can afford to pay you more: they know exactly how long they have your cash and can lend it out with confidence. You're essentially lending money to the bank, and the interest is your payment for doing so.
Key Takeaways
- A CD locks your money away for a set term—typically three months to five years—and pays a fixed interest rate higher than a regular savings account.
- You can withdraw your money early, but most banks charge a penalty that eats into or wipes out your interest earnings.
- CDs are FDIC-insured up to $250,000 per depositor per bank, so your principal is protected even if the bank fails.
- The interest rate you receive depends on the CD term length, current market rates, and the bank you choose—rates vary significantly between institutions.
- When your CD matures, you can cash it out, move the money to a savings account, or roll it into a new CD at the current rate.
How CD terms and interest rates work
CDs come in different lengths, called terms. Common terms are three months, six months, one year, two years, three years, and five years. Some banks offer longer terms up to ten years. The longer the term, the higher the interest rate the bank typically offers—because they get to hold your money longer and lend it out for more time.
The interest rate is fixed, meaning it doesn't change over the life of the CD. If you buy a one-year CD at 4.5%, you'll earn 4.5% for the entire year, even if market rates drop to 2% next month. This works both ways: if rates rise to 6%, you're locked in at 4.5%. The rate you receive also depends on how much you deposit and which bank you use—online banks often pay higher rates than brick-and-mortar branches.
Interest on a CD is usually compounded daily or monthly and added to your account when the CD matures. Some banks let you choose to receive interest payments during the term instead, but that's less common.
What happens if you need your money before the CD matures
You can withdraw money from a CD before the term ends, but the bank will charge you an early withdrawal penalty. This penalty is typically a certain number of months' worth of interest. For example, a bank might charge a penalty equal to three months of interest if you withdraw early from a one-year CD.
The penalty can be substantial. If you earn $100 in interest over the year but the penalty is $75, you walk away with only $25 in earnings—or possibly nothing if the penalty exceeds what you've earned so far. In rare cases, the penalty can even eat into your principal, meaning you get back less than you deposited. Always read the CD agreement to see what the penalty is before you buy.
Some banks offer no-penalty CDs that let you withdraw early without a fee, but these pay lower interest rates to offset the bank's risk. If you think you might need the money, a no-penalty CD or a regular savings account might be a better choice than a traditional CD.
FDIC insurance and what it covers
CDs held at FDIC-insured banks are protected up to $250,000 per depositor per bank. This means if the bank fails, the federal government guarantees you'll get your money back—principal plus any interest earned up to the maturity date. This protection applies even if the bank goes under the day before your CD matures.
The $250,000 limit applies per bank, not per CD. If you have three CDs at the same bank totaling $300,000, only $250,000 is covered. However, if you split your money across different banks, each bank's $250,000 coverage is separate. You can also increase coverage by opening CDs in different ownership categories—for example, a CD in your name and a separate CD in a joint account with your spouse would each be covered up to $250,000.
Most banks display their FDIC insurance status on their website. If you're unsure, you can search the FDIC's bank database online to confirm a bank is insured before you deposit money.
When a CD matures and what your options are
When your CD reaches its maturity date, the bank will notify you (usually 10 to 30 days before). At that point, you have three main choices: cash out the money, move it to a savings account at the same bank, or roll it into a new CD.
If you do nothing, many banks will automatically roll your money into a new CD at the current rate for the same term length. This is called an automatic renewal. You typically have a grace period—often 7 to 10 days after maturity—to withdraw the money or change your instructions without penalty. After that grace period, you're locked in again. Read your CD agreement to understand your bank's renewal policy.
If rates have risen since you bought your original CD, rolling into a new CD lets you lock in the higher rate. If rates have fallen, you might prefer to move the money to a savings account or shop around at other banks for better rates before committing to another CD.
How CDs compare to other savings options
A regular savings account offers flexibility—you can withdraw money anytime without penalty—but pays much lower interest, often 0.01% to 0.5%. A money market account sits in the middle: it pays more than savings but less than CDs, and usually lets you write checks or make a limited number of withdrawals per month. A CD pays the highest interest but locks your money away and charges a penalty if you need it early.
The best choice depends on your situation. If you have money you won't need for a year or more and want the highest may provide return, a CD makes sense. If you might need the money within months, a savings account or money market account is safer. If you're unsure how long you can commit, a no-penalty CD or a short-term CD (three or six months) splits the difference.
Interest rates change constantly, so comparing rates across banks before you buy is worth your time. Online banks typically offer higher CD rates than traditional banks because they have lower overhead costs.
Taxes on CD interest and how to report it
Interest earned on a CD is taxable income. The bank will send you a Form 1099-INT in January showing how much interest you earned during the previous year. You report this on your tax return, and you owe federal income tax on it at your regular tax rate. Some states also tax CD interest.
The tax is due even if the bank didn't send you the interest as cash—if interest was added to your CD balance, it's still taxable. This is one reason CDs held in tax-advantaged accounts like IRAs can be useful: the interest grows tax-free until you withdraw it in retirement.
If you withdraw money early and pay a penalty, you can deduct the penalty from your taxable interest income on your tax return. For example, if you earned $200 in interest but paid a $50 early withdrawal penalty, you report $150 as taxable income.
Frequently Asked Questions
Can I add more money to a CD after I open it?
No. A CD is a fixed agreement for a fixed amount. Once you open it, you cannot add more money to that CD. If you want to deposit additional funds, you would need to open a separate CD or use a savings account. Some banks let you open multiple CDs at different times.
What's the difference between a CD and a savings account?
A savings account lets you withdraw money anytime without penalty and has no maturity date, but pays lower interest. A CD locks your money for a set term and pays higher interest, but charges a penalty if you withdraw early. Choose a CD if you won't need the money; choose savings if you might.
Do I have to pay taxes on CD interest?
Yes. CD interest is taxable income reported on Form 1099-INT. You owe federal income tax on it at your regular rate, and possibly state tax depending on where you live. The tax is due even if the interest was added to your balance rather than paid to you in cash.
What happens if the bank fails while my CD is open?
Your money is protected by FDIC insurance up to $250,000. The federal government guarantees you'll receive your principal plus accrued interest up to the maturity date, even if the bank goes under. You don't need to do anything—the FDIC handles the payout automatically.
Can I cash out my CD early without a penalty?
Standard CDs charge an early withdrawal penalty. However, some banks offer no-penalty CDs that let you withdraw without a fee, though they pay lower interest rates. Check with your bank about whether they offer this option or if a shorter-term CD might work better for your situation.