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

A certificate of deposit (CD) is a product offered by banks and credit unions. You give them a sum of money — typically $500 to $100,000, though minimums vary — and agree not to touch it for a fixed period. In return, the bank pays you a higher interest rate than a regular savings account would. When the term ends, you get your original money back plus the interest earned.

The trade-off is simple: you lose access to your cash for the duration. If you withdraw before the term is up, you pay a penalty — usually a few months' worth of interest. That penalty is why CDs work best for money you genuinely won't need in the near term.

CDs are insured by the Federal Deposit Insurance Corporation (FDIC) if held at a bank, or by the National Credit Union Administration (NCUA) if held at a credit union. That means if the institution fails, your deposit is protected up to $250,000. This makes CDs one of the safest places to put money.

Key Takeaways

  • You deposit money for a fixed term — typically three months to five years — and cannot withdraw it without paying a penalty.
  • CDs pay higher interest rates than savings accounts because the bank knows exactly how long it will hold your money.
  • Your deposit is federally insured up to $250,000, making CDs a low-risk way to earn interest.
  • The penalty for early withdrawal usually equals a few months of interest, so only use a CD for money you won't need soon.
  • CD rates change based on what the Federal Reserve does with interest rates, so rates available today may be different in three months.

How CD terms and interest rates work

When you open a CD, you choose the term length. Common options are three months, six months, one year, two years, three years, and five years. Some banks offer longer terms or shorter ones. The longer the term, the higher the interest rate typically is — a five-year CD will pay more than a one-year CD because the bank gets to use your money for longer.

The interest rate you receive is locked in when you open the CD. If rates rise after you buy the CD, you do not benefit — you keep earning the rate you agreed to. If rates fall, you are protected: you keep earning the higher rate. This is why people sometimes "ladder" CDs by opening several with different term lengths, so money matures at different times and can be reinvested if rates have changed.

When your CD reaches maturity (the end of its term), the bank notifies you. You then have a grace period — usually seven to ten days — to decide what to do. You can withdraw the money, open a new CD, or let it roll over into a new CD at whatever the current rate is. If you do nothing, most banks automatically renew it at the new rate.

What happens if you need the money early

Withdrawing before maturity triggers an early withdrawal penalty. The penalty amount varies by bank and by term length. A three-month CD might have a penalty of one month's interest; a five-year CD might have a penalty of six months' interest. Some banks charge a flat dollar amount instead.

The penalty comes out of your interest earnings first. If you have earned enough interest to cover it, you lose the gain but get your principal back. If you have not earned enough interest yet, the penalty reduces your principal — you get back less than you deposited. This is why early withdrawal should be a last resort, not a plan.

A few banks offer "no-penalty CDs" that let you withdraw without a penalty, but they pay lower interest rates to offset that flexibility. These are worth considering if you think you might need access to the money but want better returns than a savings account offers.

CDs versus savings accounts and money market accounts

A regular savings account has no term and no penalty for withdrawal, but it pays very little interest — often less than 0.01 percent. A CD locks up your money but pays significantly more, sometimes three to five times as much depending on the rate environment.

A money market account sits between the two. It typically pays more than a savings account but less than a CD, and it lets you withdraw money without penalty (though there may be limits on how often you can withdraw per month). Money market accounts are useful if you want better returns than savings but need some flexibility.

The choice depends on when you might need the money. If you have an emergency fund, keep it in a savings account or money market account where you can access it instantly. If you have money you will not need for a year or more, a CD usually makes sense because the higher rate is worth the loss of access.

How CD rates are set and what affects them

Banks set CD rates based on what the Federal Reserve does with its benchmark interest rate. When the Fed raises rates, banks eventually raise CD rates to attract deposits. When the Fed cuts rates, CD rates fall. This happens with a lag — banks do not change rates instantly, and rates on new CDs may differ from rates on existing ones.

Competition among banks also matters. In a market where many banks are competing for deposits, rates go up. When deposits are plentiful and banks do not need more money, rates stay low. This is why shopping around for CD rates is worth doing — the same bank might offer 4.5 percent on a one-year CD while another offers 5.0 percent.

The term length also affects the rate. Banks use something called the yield curve to decide how much more to pay for longer terms. In normal times, a five-year CD pays more than a one-year CD. In unusual times, the curve can invert, meaning short-term rates are higher than long-term rates.

Where to open a CD

You can open a CD at any bank or credit union. You can also open one online through an online bank, which often pays higher rates than brick-and-mortar banks because they have lower overhead. Online banks like Marcus, Ally, and American Express Personal Savings are common sources for competitive CD rates.

Before opening a CD, confirm that the institution is FDIC-insured (if it is a bank) or NCUA-insured (if it is a credit union). You can check this on the FDIC or NCUA website. Also read the fine print about the early withdrawal penalty and the grace period for renewal, because these vary.

If you have more than $250,000 to deposit, you can open multiple CDs at different banks to keep each one under the insurance limit. Some people also use brokered CDs, which are CDs purchased through a brokerage firm, but these have different rules and are more complex.

Tax treatment of CD interest

Interest earned on a CD is taxable income in the year it is earned, even if you do not withdraw the money. The bank will send you a 1099-INT form at tax time showing how much interest you earned. You report this on your tax return.

If you withdraw early and pay a penalty, you can deduct the penalty from your taxable interest income on your tax return. This does not eliminate the tax hit, but it reduces it slightly. Keep records of any early withdrawal penalties you pay.

If you hold a CD in a tax-advantaged account like an IRA, the interest is not taxed until you withdraw from the account. This is one reason some people use CDs inside retirement accounts.

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 invest more money, you open a separate CD. This is different from a savings account, where you can deposit money anytime.

What happens if the bank fails while I have a CD?

Your deposit is protected by FDIC insurance up to $250,000. The FDIC will either transfer your CD to another bank or pay you directly. You do not lose money, and you keep earning interest through the maturity date.

Is there a best CD term to choose?

It depends on when you need the money and what you think rates will do. If you need the money in two years, a two-year CD makes sense. If you are unsure, laddering — opening CDs with different terms — lets you reinvest portions of your money as rates change.

Can I move a CD to a different bank?

You can withdraw the money and open a new CD elsewhere, but you will pay the early withdrawal penalty. Some banks allow CD transfers without penalty, but this is rare. It is usually cheaper to wait for maturity.

Do I have to renew my CD when it matures?

No. When a CD matures, you can withdraw the money, open a new CD, or move the money to a savings account or another product. If you do nothing, most banks automatically renew it at the current rate, but you have a grace period to make a different choice.