Certificate of Deposit (CDs) - Meaning, Features & Benefits (2024)

FAQs

Certificate of Deposit (CDs) - Meaning, Features & Benefits? ›

A certificate of deposit (CD) is a type of savings account that pays a fixed interest rate on money held for an agreed-upon period of time. CD rates are usually higher than savings accounts, but you lose withdrawal flexibility. If you withdraw your CD funds early, you'll be charged a penalty.

A certificate of deposit (CD) is a savings account that holds a fixed amount of money for a fixed period of time, such as six months, one year, or five years, and in exchange, the issuing bank pays interest. When you cash in or redeem your CD, you receive the money you originally invested plus any interest.

Higher Rates

Compared to savings accounts or money market accounts, CDs potentially can offer higher interest rates on deposits. That's because you agree to keep your money in the CD for a set time period. The interest rate and APY you earn depends on the bank, the CD term and the current interest rate environment.

The biggest risk to CD accounts is usually an interest-rate risk, as federal rate cuts could lead banks to pay out less to savers.

The exact amount will depend on the term length and the annual percentage yield (APY). If you invest $10,000 into a one-year CD with an average APY of 1.85%, you'll earn $185 in interest over the term. If you invest $10,000 into a one-year CD with a much higher APY of 6.00%, you'll earn $600 in interest over the term.

CDs are a relatively risk-free way to grow your funds, but they also have some downsides. Mapping out plans to build your savings can be challenging, especially when interest rates fluctuate. A certificate of deposit (CD) is a good alternative if you're risk-averse when it comes to investing.

That said, there are factors that could lead you to limit your deposit amount — including the maximum amount your CD account is insured for by the NCUA or FDIC, which is typically $250,000 per depositor, per account. "There is no hard and fast rule on the maximum amount," says Kevin L.

Disadvantages of investing in CDs

The penalty ranges from a minimum of multiple months' worth of interest to more, depending on the bank and term of the CD. If you open a 12-month CD and need to withdraw the money before it reaches the maturity date, you might lose three months' worth of interest that you earned.

The highest certificates of deposit (CDs) rates today are offered by Merchants Bank of Indiana (5.92%), First Federal of Lakewood (5.61%), Maries County Bank (5.51%) and Shoreham Bank (5.50%). You can see the full list of the highest-paying CDs here.

CDs are one of the safest ways to store money and earn a set rate of interest, which can help you better plan your finances. CDs opened at FDIC-insured banks, or credit unions backed by the NCUA, are guaranteed by the federal government.

Do you pay taxes on CDs? ›

Interest earned on CDs is considered taxable income by the IRS, regardless of whether the money is received in cash or reinvested. Interest earned on CDs with terms longer than one year must be reported and taxed every year, even if the CD cannot be cashed in until maturity.

A CD offers peace of mind if you're more averse to risk, said Billy Cho, Citi's financial expert and Manhattan market leader. As long as you open a CD with a financial institution that's insured by the FDIC or the NCUA, your CD is protected up to $250,000 per person, per account category in case of a bank failure.

Federal law sets a minimum penalty on early withdrawals from CDs, but there is no maximum penalty. If you withdraw money within the first six days after deposit, the penalty is at least seven days' simple interest.

How much interest would you make on a $5,000 CD? We estimate that a $5,000 CD deposit can make roughly $25 to $275 in interest after one year. In comparison, a $10,000 CD deposit makes around $50 to $550 in interest after a year, depending on the bank.

While that amount will be different for everyone, you should keep a few things in mind. First, a minimum amount is usually required. Most CDs have a minimum deposit between $500 and $2,500, though some can be lower or higher than this range.

Some terms might be shorter, such as only a few months. Others could be longer, like 2 years, 5 years or even longer. CDs also typically come with a fixed savings interest rate, which is money you earn from the bank in exchange for leaving your money in the account. This rate can show you how much your money will earn.

Expert-Verified Answer. Customers deposit their money for a set period of time or pay a penalty for withdrawal is a feature of a certificate of deposit (CD) .

Disadvantages of investing in CDs

Once you decide on the term of the CD, whether it's six months or 18 months, it can't be changed after the account is funded. As noted previously, since CDs have a set interest rate and maturity date, you typically can't withdraw the money from the CD without paying a penalty.