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

CD stands for certificate of deposit. When you open one, you give the bank a sum of money — say $1,000 or $5,000 — and promise not to withdraw it for a specific period. That period might be three months, six months, one year, or five years. In return, the bank pays you a higher interest rate than it would on a regular savings account. The longer you agree to leave the money alone, the higher the rate usually is.

The bank uses your money during that time, lending it out or investing it. That is why they can afford to pay you more. When your time period ends — this is called the maturity date — you get your original money back plus all the interest it earned. You can then withdraw it, move it to another account, or open a new CD.

A CD is not a risky investment. The Federal Deposit Insurance Corporation (FDIC) protects CDs the same way it protects regular savings accounts: if the bank fails, the government guarantees your money up to $250,000. This makes a CD one of the safest places to keep money that you know you will not need for a while.

Key Takeaways

  • A CD requires you to leave money untouched for a fixed period in exchange for a higher interest rate than a regular savings account offers.
  • The maturity date is when your CD term ends and you can withdraw your money plus interest without penalty.
  • If you withdraw money before the maturity date, the bank charges an early withdrawal penalty that reduces your earnings.
  • FDIC insurance protects your CD up to $250,000, the same as a regular savings account.
  • Interest rates on CDs vary by bank, by term length, and by how much money you deposit.

Why the interest rate is higher on a CD than a savings account

A regular savings account lets you withdraw money whenever you want. The bank never knows how long it will have your money, so it cannot plan ahead or lend it out confidently. Because of that uncertainty, the bank pays a lower interest rate — sometimes almost nothing.

A CD removes that uncertainty. The bank knows exactly when you will withdraw the money. It can lend that money out for the same period, confident it will get it back in time. Because the bank's risk is lower and its planning is easier, it shares some of that benefit with you by paying a higher rate.

The longer the CD term, the higher the rate usually is. A three-month CD might pay 4% annual interest, while a five-year CD from the same bank might pay 5%. The bank is willing to pay more because it has your money for longer and can make more use of it.

What happens if you need the money before the maturity date

You can withdraw money from a CD before the maturity date, but the bank will charge you an early withdrawal penalty. This penalty is a fee that comes out of your interest earnings, or sometimes out of your principal (the original amount you deposited).

The penalty varies by bank and by CD term. 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 or more. Before you open a CD, the bank must tell you what the penalty is — it will be in the disclosure document you receive or see online.

Because of this penalty, only put money into a CD if you are confident you will not need it before the maturity date. If you might need it sooner, a regular savings account is a better choice, even though the interest rate is lower.

How much money you need to open a CD and what rates depend on

Most banks require a minimum deposit to open a CD. This might be $500, $1,000, $2,500, or more — it depends on the bank and sometimes on the CD term. Some online banks have lower minimums than brick-and-mortar banks. A few banks offer CDs with no minimum at all.

The interest rate you receive depends on three things: the bank you choose, the length of the term, and how much you deposit. Different banks pay different rates, even for the same term length. A one-year CD at Bank A might pay 4.5%, while a one-year CD at Bank B pays 4.75%. Shopping around matters.

Some banks also pay higher rates if you deposit more money. A $10,000 CD might pay 4.5%, while a $50,000 CD at the same bank might pay 4.75%. The bank will list these rate tiers when you are looking at CD options.

The difference between a CD and a money market account

A money market account is sometimes confused with a CD, but they work differently. A money market account is a savings account that pays a higher interest rate, similar to a CD. However, you can withdraw money from it whenever you want, without a penalty. The trade-off is that the interest rate is usually lower than a CD rate, and the bank may require a larger minimum deposit.

If you want the safety and higher rate of a CD but think you might need the money sooner, a money market account is worth comparing. You will earn less interest, but you will have more flexibility. The FDIC protects both CDs and money market accounts up to $250,000.

What to know about CD ladders and CD terms

Some people open multiple CDs with different maturity dates — for example, one CD that matures in one year, another in two years, and another in three years. This is called a CD ladder. The advantage is that money becomes available at different times, so you are not locked in completely. Every year, one CD matures and you can decide whether to withdraw the money, spend it, or open a new CD.

CD terms range from as short as three months to as long as ten years or more. Shorter terms have lower rates but give you access to your money sooner. Longer terms have higher rates but tie up your money for years. There is no "right" term — it depends on when you think you will need the money and what rate the bank is offering.

Some banks also offer no-penalty CDs, which let you withdraw your money early without a penalty. The trade-off is that the interest rate is lower than a regular CD. These can be useful if you want a higher rate than a savings account but are not sure you can commit to the full term.

How interest is calculated and paid on a CD

The interest rate on a CD is an annual percentage rate, or APY. This is the amount you earn in one year, expressed as a percentage of your deposit. If you open a $1,000 CD with a 5% APY, you will earn $50 in interest over one year (before taxes).

If your CD term is shorter than one year — say, three months — the bank divides the annual rate by four and pays you one-quarter of the annual interest. If your CD term is longer than one year, the bank compounds the interest, meaning you earn interest on your interest.

The bank pays the interest in different ways depending on the CD. Some banks add the interest to your CD balance automatically. Others deposit it into a linked savings account. Some let you choose. When the CD matures, you receive the original deposit plus all accumulated interest.

Frequently Asked Questions

Can I move money from a CD to another bank?

Yes. When your CD matures, you can withdraw the money and deposit it anywhere else. If you withdraw before the maturity date, you will pay the early withdrawal penalty. Some banks allow you to transfer a CD to another bank without closing it, but this is less common — ask your bank if this option exists.

What happens to my CD when it matures?

When the maturity date arrives, the bank will notify you. You then have a window of time — usually five to ten days — to decide what to do. You can withdraw the money, open a new CD at the same bank, or let the bank automatically renew it into a new CD at the current rate. If you do nothing, most banks automatically renew.

Do I pay taxes on CD interest?

Yes. CD interest is taxable income. The bank will send you a Form 1099-INT at the end of the year showing how much interest you earned, and you will report this on your tax return. This is true even if you did not withdraw the money.

Is a CD a good place to keep an emergency fund?

A CD is not ideal for an emergency fund because you cannot access the money without paying a penalty. An emergency fund should be in a regular savings account where you can withdraw it when ready. A CD is better for money you know you will not need for several months or longer.

What if interest rates go up after I open my CD?

You are locked into the rate you agreed to when you opened the CD. If rates rise, you will earn less than you could have earned in a new CD. This is one reason some people use CD ladders — when one CD matures, they can open a new one at the current (possibly higher) rate.