A certificate of deposit is a savings account where you agree to leave money untouched for a set time in exchange for a higher interest rate

When you open a certificate of deposit (CD), you give a bank or credit union a lump sum of money. In return, they promise to pay you a fixed interest rate for a fixed period — typically three months to five years, though some go longer. You cannot withdraw the money before that time ends without paying a penalty, usually a loss of some or all of the interest you would have earned.

The tradeoff is straightforward: you give up access to your cash, and the bank gives you a better interest rate than a regular savings account. A regular savings account at most banks currently pays less than 0.5% annually. A one-year CD at the same bank might pay 4% or 5%, depending on market conditions and the bank's rates. The longer you lock your money away, the higher the rate usually climbs.

CDs are FDIC-insured at banks and NCUA-insured at credit unions, meaning your deposit is protected up to $250,000 if the institution fails. This makes them one of the safest places to keep money, though the safety comes with the cost of reduced access.

Key Takeaways

  • You deposit a fixed amount of money for a fixed time period and receive a may provide interest rate that does not change.
  • Withdrawing money before the term ends triggers an early withdrawal penalty, typically a loss of three to twelve months of interest.
  • CD rates vary by bank, by term length, and by how much money you deposit — shopping around can mean hundreds of dollars in difference.
  • When your CD matures, you can withdraw the money, open a new CD, or let it roll over into a new term at the bank's current rate.
  • CDs work best for money you know you will not need for several months or years and want to protect from market risk.

How the interest rate and term length work together

The term is how long your money stays locked in the CD. Common terms are three months, six months, one year, two years, and five years. Some banks offer one-month or ten-year terms, but these are less common. The longer the term, the higher the interest rate the bank will usually offer you, because they get to hold your money for longer.

The interest rate is what the bank pays you for letting them use your money. This rate is fixed when you open the CD and does not change, even if the bank raises or lowers its rates later. If you lock in 5% for one year and the bank drops to 3% the next month, you still earn 5%. If rates climb to 6%, you still earn 5%. This predictability is one reason people choose CDs — you know exactly what you will earn.

Interest on a CD compounds, meaning you earn interest on your interest. How often it compounds (daily, monthly, quarterly) depends on the bank's terms. Daily compounding earns you slightly more than monthly compounding on the same rate, but the difference is usually small. The bank will tell you the annual percentage yield (APY), which accounts for compounding and shows you the true annual return.

What happens if you need the money before the CD matures

Most CDs charge an early withdrawal penalty if you take your money out before the term ends. The penalty is usually stated as a number of months of interest — for example, "three months of interest" or "six months of interest." On a $10,000 CD earning 5% annually, three months of interest is about $125, so that would be your penalty.

Some banks charge a flat dollar amount instead, and a few newer online banks charge no penalty at all. Before you open a CD, ask the bank what the penalty is and get it in writing. This matters because if you withdraw early and the penalty is large, you could end up with less money than you started with.

A few banks offer no-penalty CDs, which let you withdraw your money without a penalty, though usually only after a short waiting period (often seven days). The tradeoff is that no-penalty CDs pay lower interest rates than regular CDs. They make sense if you think you might need the money but want better returns than a savings account.

Shopping for CDs and comparing rates

CD rates vary significantly between banks. A five-year CD at one bank might pay 4.5% while another pays 3.8%. Over five years on a $25,000 deposit, that difference adds up to roughly $2,000 in extra earnings. This is why comparing rates before you commit matters.

Online banks typically offer higher CD rates than brick-and-mortar banks because they have lower overhead costs. Credit unions sometimes offer competitive rates, especially if you are a member. You can compare rates on sites that list current offerings, though you will need to visit each bank's website to open the account.

The amount you deposit can also affect the rate. Some banks offer higher rates for larger deposits — a $100,000 CD might pay 0.5% more than a $10,000 CD. Ask whether the bank has rate tiers and whether you may have access to for a higher rate with your deposit amount.

What happens when your CD matures

When the term ends, your CD matures. At that point, you have three choices: withdraw the money, open a new CD, or let the bank automatically roll it over into a new CD at the current rate.

If you do nothing, most banks will automatically roll your CD into a new term at the same length (for example, a one-year CD rolls into another one-year CD). The new rate will be whatever the bank is currently offering, not the rate you locked in before. This can work in your favor if rates have risen, or against you if rates have fallen. To avoid an unwanted rollover, contact your bank a few days before maturity and tell them what you want to do.

If rates have dropped significantly since you opened your CD, you might consider moving your money to a high-yield savings account instead, which offers more flexibility. If rates have risen, you can open a new CD at the higher rate. The bank cannot force you to stay, and you have a grace period (usually seven to ten days after maturity) to decide.

CDs versus other savings options

A high-yield savings account pays interest similar to or sometimes better than short-term CDs, but you can withdraw money anytime without penalty. The tradeoff is that the rate can change at any time, whereas a CD rate is locked in. If you think you might need the money within a year, a high-yield savings account is usually more practical.

A money market account is a hybrid: it pays interest like a savings account but sometimes offers rates closer to CDs. You get limited check-writing and debit card access, but you cannot withdraw as freely as a regular savings account. Money market accounts work well for money you want to keep accessible but also want to earn decent interest on.

Treasury bills and bonds are government-backed securities that work similarly to CDs — you lock in money for a set time and earn a fixed return. They are backed by the U.S. government rather than FDIC insurance, and they are bought and sold on the secondary market, which adds complexity. For most people saving smaller amounts, CDs are simpler.

Tax considerations and reporting

Interest earned on a CD is taxable income in the year you earn it, even if you do not withdraw the money. If your CD earns $500 in interest during the year, you owe income tax on that $500. The bank will send you a Form 1099-INT at the end of the year showing how much interest you earned, and you report this on your tax return.

If you withdraw money early and pay a penalty, you can deduct the penalty from your taxable interest income. For example, if you earned $500 in interest but paid a $150 penalty for early withdrawal, you report $350 as taxable interest. Keep records of any penalties you pay.

CDs held in an IRA (individual retirement account) follow different tax rules — the interest is not taxed until you withdraw money from the IRA in retirement. If you are saving for retirement, a CD IRA might make sense, though you face penalties for withdrawing before age 59½.

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 that amount stays the same. If you want to save more, you open a separate CD. Some banks let you open multiple CDs at different times or with different term lengths.

What if the bank fails while my money is in a CD?

Your deposit is protected up to $250,000 by FDIC insurance (at banks) or NCUA insurance (at credit unions). If the bank fails, the insuring agency pays you the full amount of your CD plus any earned interest. This protection applies even if the bank goes under before your CD matures.

Is there a minimum amount I have to deposit?

Most banks require a minimum deposit to open a CD, commonly $500 to $2,500, though some online banks have no minimum. A few banks offer CDs with minimums as low as $100. Check the bank's requirements before you start the process.

Can I move a CD to a different bank?

You can withdraw your money when the CD matures and move it to another bank's CD, but you cannot transfer an active CD directly. If you withdraw early, you pay the penalty. When your CD matures, you have a grace period to move the money without penalty.

What if I need the money for an emergency?

You can withdraw early and pay the penalty, though this reduces your earnings. If the penalty is large relative to your interest, you might end up with less than you started with. No-penalty CDs avoid this problem but pay lower rates. For true emergency funds, a savings account is more practical than a CD.