What a Certificate of Deposit Account Is
A Certificate of Deposit (CD) is a savings account where you agree to leave money untouched for a fixed period of time in exchange for a higher interest rate than a regular savings account. You deposit a lump sum, the bank holds it, and at the end of the term — which might be three months, one year, five years, or longer — you get your money back plus the interest earned.
The trade-off is straightforward: you lock in your money for the duration. If you withdraw before the term ends, you pay a penalty, usually a portion of the interest you would have earned. The bank knows exactly how long it will hold your money, so it pays you more than it would for a regular savings account where you can withdraw anytime.
CDs are issued by banks and credit unions. The interest rate is fixed when you open the account, so you know exactly how much you will earn. The rate does not change, even if the bank raises rates on new CDs later.
Key Takeaways
- You deposit a fixed amount of money for a set term, and the bank pays you a may provide interest rate that does not change during that term.
- Early withdrawal before the term ends triggers a penalty, typically a loss of some or all of the interest you earned.
- CD rates are higher than regular savings accounts because your money is locked in and the bank can count on having it for a known period.
- The Federal Deposit Insurance Corporation (FDIC) insures CDs up to $250,000 per depositor per bank, the same as regular savings accounts.
How the Interest Rate and Term Work Together
When you open a CD, you choose both the amount you deposit and the length of the term. Common terms are three months, six months, one year, two years, three years, and five years, though banks offer other lengths too. The longer the term, the higher the interest rate is usually — but not always. Rate differences depend on what the bank expects interest rates to do and how much money it needs to borrow from depositors.
The interest rate you receive is fixed, meaning it stays the same for the entire term. If you open a one-year CD at 4.5 percent, you earn 4.5 percent for the full year, regardless of whether the bank raises or lowers its rates on new CDs after you open yours. This certainty is part of what makes CDs predictable: you can calculate exactly how much money you will have when the term ends.
Interest compounds at intervals the bank sets — daily, monthly, or quarterly — and is added to your account. Some banks let you choose whether to receive interest payments during the term or have all interest added at maturity.
Early Withdrawal Penalties and What They Cost
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 bank might charge a penalty of three months of interest, meaning if your CD would have earned $100 in interest, you lose $25 (three months' worth) and receive the remaining $75 plus your original deposit.
Penalties vary widely between banks and between different CD terms at the same bank. A three-month CD might have a penalty of one month of interest, while a five-year CD might have a penalty of six months or more. Read the CD agreement before you open the account to see what the penalty is — it is usually stated in the terms and conditions.
Some banks offer no-penalty CDs, which let you withdraw your money early without losing interest, though the interest rate on these is lower than on traditional CDs. These exist to give you more flexibility, but you pay for that flexibility in a lower rate.
FDIC Insurance and Account Safety
CDs held at FDIC-insured banks are protected up to $250,000 per depositor per bank. This means if the bank fails, the FDIC will return your deposit and accrued interest up to that limit. Credit unions offer similar protection through the National Credit Union Administration (NCUA), also up to $250,000.
If you have more than $250,000 to deposit, you can open CDs at different banks to keep each one under the insurance limit. You can also open a CD in your name alone and another in joint ownership with someone else at the same bank — these are counted separately for insurance purposes.
The insurance covers your principal and any interest earned up to the maturity date, even if you have not yet received the interest payment. It does not cover losses from early withdrawal penalties.
How CDs Compare to Regular Savings Accounts
A regular savings account lets you deposit and withdraw money anytime without penalty. In exchange, the interest rate is lower — often much lower — than a CD rate. A savings account is liquid, meaning your money is always accessible. A CD is illiquid until maturity unless you are willing to pay the early withdrawal penalty.
If you know you will not need the money for a specific period, a CD pays more. If you might need it sooner, a savings account is more flexible. Some people use both: a CD for money they are certain they will not touch, and a savings account for an emergency fund.
Money market accounts sit between the two. They usually pay more than savings accounts but less than CDs, and they offer limited check-writing or debit card access while still requiring you to keep a minimum balance.
What Happens When Your CD Matures
When the term ends, your CD reaches maturity. At that point, the bank deposits your principal plus all earned interest into your account. You then have a window — usually seven to ten days, depending on the bank — to decide what to do with the money.
You can withdraw the entire amount, move it to a different account, or renew the CD by opening a new one. If you renew, you lock in a new rate based on current market conditions, which might be higher or lower than your previous CD. If you do nothing within the grace period, many banks automatically renew your CD at the current rate for the same term length.
Check your bank's renewal policy before your CD matures so you are not surprised by an automatic renewal at a rate you did not choose.
Tax Treatment of CD Interest
Interest earned on a CD is taxable income in the year it is earned, even if you do not withdraw it. If your CD earns $500 in interest, you owe income tax on that $500 in the tax year it was earned, regardless of whether the interest was paid to you or added to the account.
The bank will send you a Form 1099-INT at the end of the year showing the interest you earned. You report this on your tax return. If the CD is held in a tax-advantaged account like a traditional IRA or Roth IRA, the tax treatment is different — consult a tax professional about your specific situation.
Early withdrawal penalties are tax-deductible in some cases. If you withdraw early and pay a penalty, you may be able to deduct the penalty from your income, which reduces your taxable income. Again, a tax professional can advise on your situation.
Frequently Asked Questions
Can I withdraw money from a CD before it matures?
Yes, but you will pay an early withdrawal penalty set by the bank. The penalty is usually a certain number of months of interest. Some banks offer no-penalty CDs that let you withdraw without losing interest, though these pay lower rates.
What is the difference between a CD and a savings account?
A savings account lets you withdraw anytime without penalty but pays lower interest. A CD locks your money for a set term and pays higher interest, but you lose some or all interest if you withdraw early. Choose a CD if you will not need the money; choose a savings account if you might.
Is my money safe in a CD?
Yes, if the bank is FDIC-insured. The FDIC protects up to $250,000 per depositor per bank, including your principal and accrued interest. Credit unions offer the same protection through the NCUA.
What happens when my CD matures?
Your principal and interest are deposited into your account. You then have a grace period (usually seven to ten days) to withdraw the money, renew the CD at the current rate, or move it elsewhere. If you do nothing, many banks automatically renew at the current rate.
Do I pay taxes on CD interest?
Yes. Interest earned on a CD is taxable income in the year it is earned, even if you do not withdraw it. The bank sends you a Form 1099-INT at year-end showing the interest, which you report on your tax return.