A CD is a savings account where you lock up your money for a set time in exchange for a higher interest rate
A certificate of deposit is a contract between you and a bank. You give the bank a lump sum of money—say $5,000—and agree not to touch it for a specific period: three months, six months, one year, five years, or whatever term you choose. In return, the bank pays you a fixed interest rate that is higher than what you would earn in a regular savings account. When the term ends, you get your original money back plus the interest.
The trade-off is straightforward: you lose access to your money during the term. If you withdraw before the term ends, you pay a early withdrawal penalty—usually a few months' worth of interest. That penalty is the cost of breaking the contract early.
CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank, so your money is protected even if the bank fails. This makes them one of the safest places to put money that you know you will not need for a while.
Key Takeaways
- You deposit a fixed amount of money and agree not to withdraw it for a set period—typically three months to five years—in exchange for a may provide interest rate.
- The interest rate on a CD is higher than a regular savings account because the bank knows exactly how long it can use your money.
- If you withdraw your money before the term ends, you lose some or all of the interest you earned as a penalty.
- CDs are FDIC-insured up to $250,000, meaning your deposit is protected if the bank fails.
- When your CD matures, you can withdraw the money, open a new CD, or let it roll over into another term at the bank's current rate.
How the interest rate and term length work together
The interest rate you receive depends on two things: what the bank is willing to pay, and how long you lock your money away. Generally, the longer the term, the higher the rate. A three-month CD might pay 4.5 percent, while a five-year CD at the same bank might pay 5.2 percent. The bank pays more for longer terms because it has may provide use of your money for a longer period.
Interest rates also change based on what the Federal Reserve does with its benchmark rate. When the Fed raises rates, banks typically raise CD rates too. When the Fed cuts rates, CD rates fall. This means the rate you see today will not be the rate you see in three months. If you want a particular rate, you have to lock it in by opening the CD now.
The interest compounds—meaning you earn interest on your interest—but the frequency varies by bank. Some banks compound daily, others monthly or quarterly. Daily compounding means slightly more money at the end, but the difference is usually small unless the CD is large or the term is long.
What happens when your CD reaches maturity
When your CD term ends, the bank sends you a notice—usually 10 to 14 days before the maturity date—telling you what happens next. You have three main options: withdraw the money, open a new CD, or let it roll over automatically.
If you do nothing, most banks automatically roll over your CD into a new one at the same term length, using the bank's current rate. If rates have dropped, you will earn less. If rates have risen, you will earn more. You usually have a grace period—often 7 to 10 days after maturity—to withdraw the money without penalty if you do not want the new CD.
If you withdraw the money, the bank deposits it into your checking or savings account, or sends you a check. There is no penalty for withdrawing after the term ends. The interest you earned is yours to keep.
Early withdrawal penalties and when they explore
If you need your money before the CD matures, you can withdraw it, but you will pay a penalty. The penalty is usually expressed as a number of months of interest. A CD with a three-month penalty means you lose three months' worth of the interest you earned. On a $10,000 CD earning 5 percent annually, that is roughly $125.
Some banks calculate the penalty differently—as a percentage of the deposit or a flat fee—so read the CD agreement before you open one. A few banks offer no-penalty CDs that let you withdraw without losing interest, but these pay lower rates because the bank is taking on more risk.
The penalty applies only to interest, not to your original deposit. You always get your principal back. If you have earned $500 in interest and the penalty is $200, you withdraw your original amount plus $300 in interest.
How CDs compare to other savings options
A regular savings account is more flexible—you can withdraw whenever you want—but it pays much less interest. A money market account sits in the middle: it pays more than savings but less than CDs, and you can write checks or make withdrawals, though usually with limits.
Treasury bills and bonds are similar to CDs in that you lock up money for a set time, but they are issued by the federal government, not banks. They are extremely safe but have different tax treatment and are harder to buy and sell before maturity.
If you have money you will not need for several years and want the highest may provide return with no risk, a CD is usually the best choice. If you might need the money sooner, a savings account or money market account is safer, even if the rate is lower.
Where to open a CD and what to compare
You can open a CD at any bank, credit union, or online bank. Rates vary significantly—an online bank might offer 5.3 percent while a brick-and-mortar bank offers 4.8 percent for the same term. It is worth checking multiple places before you decide.
When comparing CDs, look at the interest rate, the term length, the early withdrawal penalty, and whether the bank compounds interest daily or less frequently. Also check whether the bank is FDIC-insured. If you are opening a CD with more than $250,000, you can spread the money across multiple banks to keep it all insured.
Some banks offer CD ladders—opening multiple CDs with different maturity dates so that some money becomes available each year. This lets you take advantage of higher rates on longer terms while still having regular access to some of your money.
Tax treatment of CD interest
The interest you earn on a CD is taxable income in the year you earn it, even if you do not withdraw the money until later. If your CD earns $500 in interest during the year, you owe income tax on that $500, whether you leave it in the CD or take it out.
The bank will send you a 1099-INT form at the end of the year showing how much interest you earned. You report this on your tax return. If you are in a high tax bracket, the after-tax return on a CD might be lower than it looks, so factor that in when deciding whether a CD makes sense for you.
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 a set number of months of interest—check your CD agreement to see exactly how much. You always get your original deposit back; the penalty comes out of the interest you earned.
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 much lower interest. A CD pays higher interest but locks your money away for a set period. If you withdraw early, you lose interest as a penalty.
Is my money safe in a CD if the bank fails?
Yes. The FDIC insures CDs up to $250,000 per depositor per bank. If the bank fails, the FDIC returns your money in full. If you have more than $250,000, you can open CDs at different banks to keep it all insured.
What happens to my CD when it matures?
The bank sends you a notice before maturity. You can withdraw the money, open a new CD, or let it roll over automatically into a new CD at the current rate. You usually have a grace period of 7 to 10 days to decide without penalty.
Do I pay taxes on CD interest?
Yes. The interest you earn is taxable income in the year you earn it, even if you do not withdraw the money. The bank sends you a 1099-INT form at the end of the year showing the interest, which you report on your tax return.