What a Certificate of Deposit Is

A certificate of deposit (CD) is an agreement between you and a bank: you give the bank a lump sum of money for a fixed period of time, and the bank pays you a set interest rate on that money. When the time period ends—called the maturity date—you get your original money back plus the interest earned.

The key difference between a CD and a regular savings account is the lock-in period. With a savings account, you can withdraw money whenever you want. With a CD, you agree not to touch the money until the maturity date arrives. In exchange, the bank gives you a higher interest rate than you would earn in a savings account.

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 by the federal government.

Key Takeaways

  • You deposit a fixed amount of money for a set time period (typically three months to five years) and receive a may provide interest rate in return.
  • You cannot withdraw the money before the maturity date without paying an early withdrawal penalty, which the bank sets when you open the CD.
  • CD interest rates are higher than savings account rates because you are committing to leave the money untouched for the full term.
  • Your deposit is FDIC-insured up to $250,000, so your principal is protected even if the bank fails.
  • When your CD matures, you can withdraw the money, open a new CD, or let the bank automatically renew it at the current rate.

How Interest Rates and Terms Work

When you open a CD, the bank tells you three things: the interest rate, the term length, and how often interest is compounded. The interest rate is locked in for the entire term—it will not change, even if the bank raises or lowers rates for new CDs.

Term lengths vary. Most banks offer CDs with terms of three months, six months, one year, two years, three years, and five years. Some banks offer longer terms (up to ten years) or shorter ones (as little as one month). The longer the term, the higher the interest rate is usually—but not always. This depends on what the bank needs and what interest rates are doing in the broader economy.

Interest is typically compounded daily, monthly, or quarterly, depending on the bank. Compounding means the bank adds earned interest to your balance, and then calculates next period's interest on the larger amount. More frequent compounding means slightly more money at maturity, but the difference is usually small.

Early Withdrawal Penalties and What They Cost

If you need the money before the maturity date, you can withdraw it—but the bank will charge you an early withdrawal penalty. This penalty is a set amount of money or a set number of months of interest, depending on the bank and the CD term.

For example, a bank might charge a penalty of three months of interest on a one-year CD. If your CD is earning $100 per year, the penalty would be $25. Another bank might charge a flat $50 penalty regardless of the term. You need to read the CD agreement before you open it to know what the penalty is.

The penalty comes out of your CD balance, not from your pocket separately. So if you withdraw early, you get your principal back minus the penalty, plus whatever interest you earned up to that point. In some cases, if you withdraw very early, the penalty can be larger than the interest you have earned, meaning you actually lose money.

What Happens When Your CD Matures

Most banks give you a window of time—usually seven to ten days—after your CD matures to decide what to do with the money. During this window, you can withdraw the full amount (principal plus interest), open a new CD, or move the money to another account.

If you do nothing during the window, many banks will automatically renew your CD for another term at the current interest rate. This is called auto-renewal. The new rate may be higher or lower than what you were earning. Check your bank's renewal notice so you know what rate you are getting before the renewal happens.

Some banks send you a notice before maturity telling you the renewal rate and the renewal date. Others do not. Call your bank or log into your account online to find out their auto-renewal policy so you are not surprised.

CD Laddering: A Strategy for Accessing Money Sooner

One way to balance higher CD rates with the need for regular access to money is called CD laddering. This means opening multiple CDs with different maturity dates instead of one large CD.

For example, instead of putting $5,000 into a five-year CD, you could put $1,000 each into a one-year, two-year, three-year, four-year, and five-year CD. After one year, the first CD matures and you can withdraw that money or reinvest it. After two years, the second one matures, and so on. This way, you have access to part of your money every year while still earning higher rates on the portions you leave locked in.

Laddering works best when interest rates are stable or rising, because you can reinvest maturing CDs at higher rates. When rates are falling, you lock in higher rates on the longer-term CDs, which protects you.

CDs Versus Savings Accounts and Money Market Accounts

A regular savings account offers flexibility: you can deposit and withdraw money whenever you want, with no penalty. The trade-off is a lower interest rate. A CD offers a higher rate but locks your money away. Choose a CD if you have money you will not need for several months or years. Choose a savings account if you need quick access to the money.

A money market account sits between the two. It usually pays more interest than a savings account but less than a CD. You can withdraw money, but there are limits on how many withdrawals you can make per month. Money market accounts are useful if you want better returns than savings but need more flexibility than a CD allows.

The interest rates on all three products change based on what the Federal Reserve does with its benchmark interest rate. When the Fed raises rates, banks raise CD rates, savings rates, and money market rates. When the Fed lowers rates, all three go down.

Tax Implications of CD Interest

The interest you earn on a CD is taxable income. The bank will send you a Form 1099-INT at the end of the year showing how much interest you earned. You report this on your federal tax return.

You owe taxes on the interest even if you do not withdraw the money—the interest is considered earned income in the year it is credited to your account, not when you withdraw it. This matters if you have a CD that matures in December but you do not touch the money until January. You still owe taxes on that interest in the year it was earned.

If you hold a CD in a tax-advantaged account like an IRA or a 401(k), the interest is not taxed until you withdraw money from the account. Talk to a tax professional if you are unsure how your specific CD will be taxed.

Frequently Asked Questions

Can I withdraw money from a CD before it matures without a penalty?

No. By definition, a CD locks your money until maturity. If you withdraw early, you pay the penalty set by the bank. Some banks offer "no-penalty CDs" that let you withdraw without a penalty, but these pay lower interest rates than regular CDs.

What is the minimum amount I need to open a CD?

Minimum deposits vary by bank and by CD term. Some banks allow CDs with minimums as low as $500 or $1,000. Others require $10,000 or more. Check with your bank for their specific minimums.

Is my money safe in a CD if the bank fails?

Yes. The FDIC insures CDs up to $250,000 per depositor, per bank. If the bank fails, the FDIC will return your money. If you have more than $250,000, only the first $250,000 is covered at that bank.

What happens if interest rates drop after I open my CD?

Your rate stays the same for the entire term. This is actually good for you—you locked in a higher rate before rates fell. When your CD matures, you will have to accept whatever the new rate is at that time.

Can I move a CD to a different bank?

Yes, but you will pay the early withdrawal penalty from your current bank. The new bank will open a new CD for you. It only makes sense to move if the new bank's rate is significantly higher and the penalty is low.