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 account at a bank or credit union where you deposit money and agree to leave it untouched for a specific period—usually three months to five years. In return, the bank pays you a fixed interest rate that is almost always higher than what a regular savings account offers. When your term ends, you get your original deposit back plus the interest earned.
The trade-off is simple: you give up access to your money for the duration of the term. If you withdraw before the term ends, you pay an early withdrawal penalty, which is typically a few months' worth of interest. The bank tells you the penalty amount upfront, so you know exactly what it costs to break the agreement.
CDs are insured by the Federal Deposit Insurance Corporation (FDIC) at banks or by the National Credit Union Administration (NCUA) at credit unions, up to $250,000 per account. This means your money is protected even if the institution fails.
Key Takeaways
- A CD locks your money for a set term (three months to five years) and pays a fixed interest rate higher than regular savings accounts.
- You can withdraw early, but you will pay a penalty—usually a few months of interest—that the bank discloses before you open the account.
- CDs are FDIC or NCUA insured up to $250,000, so your principal is protected regardless of what the bank does.
- The interest rate and penalty amount are fixed when you open the CD, so you know exactly what you will earn and what it costs to exit early.
How the interest rate and term length work together
The longer the term, the higher the interest rate the bank will offer. A three-month CD might pay 4.5 percent annually, while a five-year CD from the same bank might pay 5.2 percent. Banks do this because they want to keep your money longer and can lend it out for longer periods at higher rates themselves.
The rate you receive is fixed, meaning it does not change for the entire term, even if the Federal Reserve raises or lowers interest rates. If you lock in 5 percent for two years and rates drop to 2 percent next month, you still earn 5 percent. If rates climb to 7 percent, you still earn only 5 percent—this is the risk you take when you commit to a CD.
Interest compounds on most CDs, usually daily or monthly. This means you earn interest on your interest. A $10,000 CD at 5 percent compounded daily will earn slightly more than one compounded monthly, though the difference is small over short terms.
What happens when your CD matures
When your term ends, your CD matures. The bank deposits your original amount plus all earned interest into your account. You then have a window—usually seven to ten days—to decide what to do next.
You can withdraw the money, move it to a regular savings account, or roll it over into a new CD. If you do nothing during the grace period, many banks automatically roll your CD into a new one at the current rate for the same term length. Read the terms carefully, because some banks will move your money to a regular savings account instead if you do not act.
Automatic rollover can work against you if rates have dropped. If your one-year CD matures when rates are lower than they were when you opened it, you may want to shop around for a better rate elsewhere rather than accept the bank's automatic renewal.
Early withdrawal penalties and when they apply
If you need your money before the term ends, you can withdraw it, but you will lose some of the interest you earned. The penalty is calculated as a set number of months of interest. A CD with a three-month penalty means you lose three months' worth of interest, regardless of how long you have held the account.
The penalty is deducted from your interest earnings first. If you have earned $200 in interest and the penalty is $150, you receive your full principal plus $50. If the penalty exceeds your interest earned, it comes out of your principal—you get back less than you deposited.
Some banks offer no-penalty CDs that let you withdraw without a penalty, but they pay lower interest rates to offset that flexibility. These are useful if you think you might need the money but want a rate better than a savings account.
CD laddering and other strategies
One way to balance the higher rate of a CD with the need for access is CD laddering. You open multiple CDs with different maturity dates—for example, one that matures in one year, one in two years, and one in three years. As each one matures, you can withdraw the money or roll it into a new longer-term CD. This gives you regular access to portions of your money while keeping the rest locked in at higher rates.
Another approach is to open a bump-up CD, which lets you increase your rate once if rates rise during your term. This protects you if you locked in a rate that later looks low. Not all banks offer bump-up CDs, and the rate increase is usually limited to one adjustment.
Some people use CDs as part of a savings ladder for a large goal—putting money into CDs with staggered maturity dates so that funds become available as they need them, without having to pay early withdrawal penalties.
Where to find CDs and how rates compare
Banks and credit unions both offer CDs. Online banks typically pay higher rates than brick-and-mortar banks because they have lower overhead costs. You can compare rates across institutions using financial websites that list current CD rates by term length and institution.
Rates change frequently, sometimes daily. A rate that is competitive today may not be next week. If you see a rate you like, open the account soon—the bank can lock in the rate you saw at the time you open it, but rates are not may provide until you fund the account.
Credit unions sometimes offer higher rates to members, especially if you have other accounts with them or maintain a minimum balance. If you belong to a credit union, check their CD rates before comparing banks.
CDs versus other savings options
A regular savings account is more flexible—you can withdraw anytime without penalty—but pays much lower interest, often under 0.5 percent. A CD pays more but locks your money away. A money market account sits between the two: it pays more than savings but less than CDs, and you can write checks or make withdrawals, though usually with limits.
If you have money you will not need for several years and want may provide returns, a CD is straightforward. If you might need the money within a year or two, a high-yield savings account or money market account may be safer because you avoid the early withdrawal penalty risk.
For very large sums, you can open multiple CDs at different banks, each insured up to $250,000, to protect the full amount under FDIC insurance.
Frequently Asked Questions
Can I withdraw from a CD before it matures?
Yes, you can withdraw anytime, but you will pay an early withdrawal penalty. The penalty is usually a set number of months of interest. If the penalty exceeds your earned interest, it comes out of your principal, so you may get back less than you deposited. The exact penalty is disclosed when you open the account.
What is the difference between a CD and a savings account?
A savings account lets you deposit and withdraw anytime with no penalty, but pays very low interest. A CD locks your money for a set term and pays higher interest, but charges a penalty if you withdraw early. CDs are better for money you will not need soon; savings accounts are better for emergency funds.
Do I have to pay taxes on CD interest?
Yes, CD interest is taxable income. The bank will send you a 1099-INT form at the end of the year showing how much interest you earned. You report this on your tax return. The interest is taxed at your ordinary income tax rate, not as a capital gain.
What happens if the bank fails while I have a CD?
Your CD is protected by FDIC insurance (at banks) or NCUA insurance (at credit unions) up to $250,000. If the bank fails, the insurance agency pays you your full principal plus accrued interest, even if the bank cannot. You are not at risk of losing your money.
Can I move a CD to a different bank?
You can withdraw your CD and move the money to another bank, but you will pay the early withdrawal penalty. You cannot transfer a CD directly without closing it first. If rates are much higher elsewhere, the penalty may be worth paying, but calculate the cost before you decide.