A certificate of deposit is a savings account where you lock your money away for a set time in exchange for a higher interest rate

When you open a CD, you agree to leave a lump sum of money untouched until a specific date — called the maturity date. In return, the bank pays you interest at a rate higher than you would get in a regular savings account. The tradeoff is simple: access your money early, and you pay a penalty. Wait until maturity, and you get the full promised rate.

CDs are offered by banks, credit unions, and online financial institutions. The interest rate, the length of the term (usually three months to five years), and the early withdrawal penalty all vary by institution. You choose which combination works for your situation.

Key Takeaways

  • You deposit a fixed amount of money and agree not to touch it until the maturity date, which can range from a few months to several years.
  • The bank pays you a set interest rate, locked in when you open the CD, regardless of whether rates rise or fall later.
  • If you withdraw money before the maturity date, you lose some or all of the interest you earned, and may pay an additional penalty.
  • CDs are insured by the FDIC (at banks) or NCUA (at credit unions) up to $250,000 per account, so your principal is protected even if the institution fails.
  • The longer the term, the higher the interest rate typically is, but you also give up access to your money for longer.

How the interest rate and term length work together

Banks set CD rates based on what the Federal Reserve is doing and what other banks are offering. A three-month CD might pay 4.5 percent, while a five-year CD from the same bank might pay 5.2 percent. The bank is paying you more for locking your money up longer because they want to use it for longer.

The interest compounds — meaning you earn interest on your interest — but the exact schedule depends on the CD. Some compound daily, some monthly, some at maturity. The more often it compounds, the slightly more you earn, but the difference is usually small unless the rate is very high.

When your CD reaches maturity, the bank deposits the principal plus all accrued interest into your account. At that point you can withdraw the money, open a new CD, or let the money sit in a regular savings account. Some banks automatically "roll over" your CD into a new one at the current rate unless you tell them not to.

What happens if you need the money before maturity

Early withdrawal penalties vary widely. A bank might charge three months of interest, or six months, or a flat fee. Some online banks charge nothing. You need to read the specific terms before you open the CD, because the penalty is the price of changing your mind.

If you withdraw early and the penalty is larger than the interest you have earned so far, you lose money — you get back less than you put in. For example, if you open a one-year CD at 4.5 percent, deposit $5,000, and withdraw after two months, you might have earned $75 in interest but face a $150 penalty, leaving you with $4,925.

Some CDs have no penalty or a very small one, but those almost always pay a lower interest rate. It is a trade-off: higher rate with a stiff penalty, or lower rate with flexibility.

How CDs compare to other savings options

A regular savings account lets you withdraw money anytime without penalty, but the interest rate is usually much lower — often under 0.5 percent. A money market account sits in the middle: higher rates than savings, but you can still access your money, though there may be limits on how often you can withdraw.

A CD locks you in but pays more. If you know you will not need the money for a year or two, a CD usually beats a savings account. If you might need it sooner, the penalty risk makes a savings account safer.

Bonds and Treasury securities also lock up your money and pay interest, but they work differently — you can sell them before maturity, though the price may have changed. CDs are simpler: you know exactly what you will get if you hold to maturity.

FDIC insurance and what it protects

Money you deposit in a CD at an FDIC-insured bank is protected up to $250,000 per account. If the bank fails, the FDIC pays you back. This protection covers the principal and any accrued interest.

The $250,000 limit applies per depositor, per bank, per account type. If you have a CD and a savings account at the same bank, they count toward the same $250,000 limit. If you have CDs at two different banks, each is insured separately up to $250,000.

Credit unions offer the same protection through the NCUA (National Credit Union Administration) up to $250,000. Online banks are FDIC-insured just like brick-and-mortar banks.

Laddering CDs to balance rate and access

Some people open multiple CDs with different maturity dates — a strategy called laddering. For example, you might open five one-year CDs, each maturing in successive years. Each year, one CD matures and you can withdraw the money or roll it into a new five-year CD. This gives you some money available each year while still locking most of it away for higher rates.

Laddering works best when you have a larger amount to invest and you want to balance the higher rates of longer terms with the flexibility of having money come due regularly. It requires more attention than a single CD, but it can be worth it if rates are attractive.

Tax implications of CD interest

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

If you withdraw money early and pay a penalty, you can deduct the penalty from your taxable interest income on your tax return. So if you earned $200 in interest but paid a $75 penalty, you report $125 as taxable income.

CDs held in a retirement account like an IRA follow different rules — the interest is not taxed until you withdraw from the account. If you are in a high tax bracket, that can make a CD in an IRA more attractive than one in a regular account.

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 is what earns interest. If you want to invest more money, you open a separate CD. Some banks let you open multiple CDs at the same time with different amounts.

What if interest rates go up after I buy a CD?

You are locked into the rate you agreed to when you opened the CD. If rates rise, your CD still pays the original rate. This is why longer-term CDs pay higher rates upfront — the bank is compensating you for the risk that rates will rise and you will be stuck with a lower return.

Is there a minimum amount I have to deposit?

Most banks require a minimum deposit to open a CD, often $500 to $2,500, though some online banks have minimums as low as $100 or none at all. Check the specific bank's terms before you decide where to open one.

What happens if the bank fails while my CD is open?

The FDIC or NCUA pays you back up to $250,000, including all interest earned to that point. Your CD does not mature early — you simply receive your money from the insurance fund. This has happened only a handful of times in recent decades.

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 at your current bank. You cannot transfer a CD itself to another institution — you have to close it and start over.