A CD is a savings product where you lend money to a bank for a fixed period in exchange for a set interest rate

A certificate of deposit (CD) is an agreement between you and a bank or credit union. You give them a sum of money — typically $500 to $100,000, though minimums vary — and they promise to pay you back that amount plus interest after a specific time period. That time period might be three months, one year, five years, or longer. In exchange for locking your money away, the bank pays you a higher interest rate than you would get from a regular savings account.

The bank uses your money during that time. They lend it out or invest it. When your CD reaches its maturity date, you get your original deposit back plus all the interest earned. If you need the money before maturity, you can withdraw it, but most CDs charge a penalty — usually a few months' worth of interest.

CDs are considered very low-risk investments because your deposit is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per bank, per account type. This means even if the bank fails, you do not lose your money. Credit unions offer similar protection through the National Credit Union Administration (NCUA).

Key Takeaways

  • A CD locks your money for a set time in exchange for a may provide interest rate higher than a savings account.
  • Your principal and interest are protected by FDIC or NCUA insurance up to $250,000 per institution.
  • Early withdrawal usually costs you a penalty, typically several months of interest, so only deposit money you will not need before maturity.
  • CD rates change based on what the Federal Reserve does with interest rates, so rates available today will not be the same next month.
  • You pay income tax on the interest you earn, even if you do not withdraw the money until maturity.

How interest rates and maturity dates work together

When you open a CD, the bank tells you two things: the interest rate and the term length. A typical CD might offer 4.5% annual interest for a one-year term, or 5.2% for a five-year term. Longer terms usually pay higher rates because the bank gets to use your money for longer. Shorter terms pay less because you could withdraw and move your money elsewhere sooner.

The interest rate is fixed, meaning it does not change during the term. If you lock in 4.5% for one year, you will earn 4.5% even if rates drop to 2% next month. That stability is one reason people use CDs — you know exactly what you will earn.

Interest compounds, usually daily or monthly, depending on the bank. That means you earn interest on your interest. A $10,000 CD at 5% annual interest compounded daily will earn slightly more than $500 over one year because the interest gets added to your balance and starts earning interest itself. The exact amount depends on how often the bank compounds.

What happens when your CD matures

When the maturity date arrives, you have choices. You can withdraw the money and the interest. You can let it roll over into a new CD at whatever rate the bank is offering at that time — usually the bank does this automatically unless you tell them not to. Or you can move the money to a different bank or investment.

Many banks have a grace period, usually 7 to 10 days, where you can change your mind about rolling over without penalty. After that window closes, if you withdraw before the new CD matures, the early withdrawal penalty applies. Read the terms carefully, because grace periods vary by bank.

If rates have risen since you opened your original CD, rolling over into a new CD at maturity locks in the higher rate. If rates have fallen, you might want to shop around or move your money to a different type of investment.

Early withdrawal penalties and when they apply

If you need your money before the CD matures, you can withdraw it, but the bank will charge a penalty. The penalty is usually expressed as a number of months of interest. A CD with a six-month interest penalty means you lose six months' worth of the interest you earned. On a $10,000 CD earning 5% annually, that penalty would be about $250.

Some banks charge a flat dollar amount instead. Others charge a percentage of the principal. The terms are in the CD agreement you sign when you open it. Before you deposit money, ask the bank what the early withdrawal penalty is. If you think you might need the money, a shorter-term CD with a smaller penalty might make more sense than a longer-term one.

A few banks offer no-penalty CDs, which let you withdraw your money early without losing interest. These CDs pay lower rates than standard CDs because the bank is taking on more risk. They are worth considering if you are not certain you can leave the money untouched.

How CDs compare to other low-risk investments

CDs are often compared to high-yield savings accounts and money market accounts. All three are FDIC-insured and very safe. The main differences are flexibility and rate.

A high-yield savings account lets you withdraw money anytime without penalty, but the interest rate is usually lower than a CD. A money market account is somewhere in between — it pays more than a regular savings account but less than a CD, and it may let you write checks or make a limited number of withdrawals per month.

Treasury bills and Treasury notes, issued by the U.S. government, are also very safe and often pay competitive rates. They are not FDIC-insured because they are backed by the government itself. They are bought and sold on the secondary market, so if you need cash before maturity, you can sell them, though the price may be higher or lower than what you paid.

Tax treatment of CD interest

The interest you earn on a CD is taxable income. You owe federal income tax on it, and usually state and local income tax too, depending on where you live. The bank will send you a Form 1099-INT at the end of the year showing how much interest you earned, and you report that on your tax return.

You pay tax on the interest even if you do not withdraw it — even if you let it roll over into a new CD. This is different from some other investments where you can defer taxes until you sell. If you hold a CD in a tax-advantaged account like an IRA or 401(k), the interest is not taxed until you withdraw from the account.

The tax impact means that the real return on your CD is lower than the stated interest rate. If you earn 5% but pay 24% in taxes on that interest, your after-tax return is closer to 3.8%. This matters more if you are in a higher tax bracket.

Where to find and compare CDs

You can open a CD at any bank or credit union. Large national banks like Chase or Bank of America offer CDs, but their rates are often lower than smaller banks or online banks. Online banks like Marcus, Ally, and American Express Bank typically pay higher rates because they have lower overhead costs.

Credit unions often pay competitive rates and may have lower minimum deposits than banks. If you belong to a credit union, ask what CD rates they offer. You can also search CD rates on comparison sites like Bankrate, DepositAccounts, or the FDIC's own BankFind tool, though these sites do not let you open an account directly — they just show you what is available.

When comparing CDs, look at the annual percentage yield (APY), not just the interest rate. APY includes the effect of compounding, so it is the true rate you will earn. A CD with a higher APY will earn you more money, all else equal.

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. Some banks offer no-penalty CDs that let you withdraw without losing interest, though they pay lower rates. Check your CD agreement to see what the penalty is before you deposit money.

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

Your money is protected by FDIC insurance up to $250,000. If the bank fails, the FDIC takes over and makes sure you get your principal and all earned interest. Credit unions have the same protection through the NCUA. You do not need to do anything — the insurance is automatic.

Is a CD a good investment if interest rates are falling?

A CD locks in your current rate, so if rates fall, you benefit because you are earning more than new CDs will pay. If rates rise, you are locked in at the lower rate. CDs work best when you think rates might fall or when you want certainty about your return.

Can I open multiple CDs at the same bank?

Yes, and each CD is insured separately up to $250,000 by the FDIC. You could open a one-year CD and a five-year CD at the same bank, and both would be fully insured. This strategy, called CD laddering, lets you access some of your money each year while keeping rates higher than a savings account.

Do I have to pay taxes on CD interest if I do not withdraw the money?

Yes. You owe income tax on the interest in the year it is earned, even if you leave it in the CD and let it roll over. The bank reports the interest to the IRS on Form 1099-INT. If the CD is in an IRA or other tax-advantaged account, taxes are deferred until you withdraw from the account.