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 CD, you deposit a lump sum — say $5,000 — and the bank locks that money away for a fixed period: three months, one year, five years, or whatever term you choose. During that time, you cannot withdraw the money without paying a penalty. In return, the bank pays you a higher interest rate than a regular savings account would offer. The longer you lock your money away, the higher the rate usually is.

The interest compounds — meaning you earn interest on your interest — and at the end of the term, you get back your original deposit plus all the interest earned. That total amount is yours to withdraw, spend, or roll into a new CD.

Key Takeaways

  • A CD requires you to deposit a fixed amount and leave it untouched for a specific period, ranging from a few months to several years.
  • Interest rates on CDs are higher than regular savings accounts because the bank knows exactly how long it can use your money.
  • If you withdraw money before the term ends, you pay an early withdrawal penalty that reduces your earnings or principal.
  • When your CD matures, you can withdraw the full amount, let it automatically renew into a new CD, or move the money elsewhere.
  • CDs are FDIC-insured up to $250,000 per depositor per bank, making them a low-risk way to save.

How the interest rate and term length work together

Banks set CD rates based on what the Federal Reserve is doing with interest rates and what other banks are offering. Right now, rates vary widely — some banks offer less than 1%, while others offer 4% or higher, depending on the term and the bank. Longer terms usually pay more: a one-year CD might pay 3%, while a five-year CD might pay 4.5%.

The trade-off is simple: the longer you commit your money, the more you earn, but the longer you cannot touch it without a penalty. If you think you might need the money in two years, a five-year CD is a bad choice because withdrawing early will cost you. If you are confident you will not need it, the longer term pays off.

What happens when your CD reaches maturity

When the term ends — say, after one year — your CD matures. At that point, you have three choices. You can withdraw the full amount (principal plus interest) and do something else with it. You can let the bank automatically roll it into a new CD at whatever rate the bank is offering at that moment. Or you can move the money to a different bank or account type.

Banks usually give you a grace period of seven to ten days after maturity to decide what to do. If you do nothing during that window, most banks will automatically renew the CD. Read your CD agreement to know your bank's policy, because renewal rates can be lower than what you earned on the original CD.

Early withdrawal penalties and when they apply

The main risk of a CD is needing your money before the term ends. If you withdraw early, you pay a penalty. That penalty is usually a certain number of months of interest — for example, three months of interest on a one-year CD, or six months on a longer term. Some banks calculate it differently, so always ask what the penalty is before you open the CD.

The penalty comes out of your earnings first. If you have earned $200 in interest and the penalty is $150, you get back your original deposit plus $50. If the penalty is larger than your interest, it comes out of your principal, meaning you get back less than you deposited. This is why CDs work best for money you genuinely will not need.

Why banks pay more for CDs than savings accounts

A regular savings account lets you withdraw money anytime. That unpredictability makes it risky for the bank — it never knows how much cash it will have on hand. A CD removes that risk. The bank knows exactly when you will withdraw the money and can lend that money out or invest it with confidence. Because the bank's risk is lower, it pays you more.

This is also why CD rates move with the broader economy. When the Federal Reserve raises rates, banks raise CD rates to stay competitive. When rates fall, CD rates fall too. If you lock in a high rate and rates drop, you win. If rates rise after you buy a CD, you are stuck with the lower rate unless you pay the early withdrawal penalty.

FDIC insurance and how your money is protected

CDs at banks that are members of the Federal Deposit Insurance Corporation (FDIC) are insured up to $250,000 per depositor per bank. This means if the bank fails, the government guarantees you get your money back, up to that limit. This protection covers your principal and all accrued interest.

If you have more than $250,000 to save, you can open CDs at multiple banks to stay within the insurance limit at each one. Credit unions offer a similar protection called NCUA insurance. Always confirm your bank is FDIC-insured before opening a CD — the bank's website will say so, or you can search the FDIC's bank database online.

CD laddering: a strategy to balance rate and access

Some savers use a strategy called CD laddering to get higher rates while still having regular access to their money. Instead of putting all $10,000 into one five-year CD, you split it into five $2,000 CDs with terms of one, two, three, four, and five years. Each year, one CD matures and you can withdraw that money or roll it into a new five-year CD at the current rate.

This approach gives you some of the higher rates of longer terms while letting you access a portion of your money every year. It also lets you take advantage of rising rates: if rates go up, you can reinvest the maturing CDs at the new, higher rate. Laddering works best if you have a larger amount to split and do not need all the money at once.

Frequently Asked Questions

Can I withdraw money from a CD before it matures?

Yes, but you will pay an early withdrawal penalty. The penalty is usually several months of interest, though it varies by bank and CD term. In some cases, the penalty can exceed your earnings and reduce your principal. Check your CD agreement to know the exact penalty before you open the account.

What is the difference between a CD and a savings account?

A savings account lets you withdraw money anytime with no penalty, but it pays a lower interest rate. A CD locks your money for a set term and pays more interest, but withdrawing early costs you. Choose a CD if you have money you will not need; choose a savings account if you want flexibility.

Do I have to pay taxes on CD interest?

Yes. CD interest is taxable income in the year it is earned. Your bank will send you a 1099-INT form at tax time showing how much interest you earned. The interest is taxed as ordinary income at your regular tax rate, not as capital gains.

What happens if I do nothing when my CD matures?

Most banks automatically renew your CD into a new term at the current rate. However, renewal rates can be lower than your original rate. You usually have a grace period of seven to ten days after maturity to withdraw the money or change your choice. Read your CD agreement to know your bank's renewal policy.

Is a CD a good place to put emergency savings?

A CD is not ideal for emergency money because you cannot access it without a penalty. Keep emergency savings in a regular savings account or money market account where you can withdraw anytime. Use CDs for money you know you will not need for several months or years.