Certificates of deposit (CDs) can help you maximize your earnings at a bank or credit union while keeping your money safer than it would be in investment vehicles like stocks and mutual funds. You avoid the risk of losing money in market crashes, so you know your cash will be there when you need it. That said, you also give up the opportunity to benefit from market gains.
Opening a CD may seem intimidating, but the process itself is relatively easy. Let’s review the basics of how CDs work and what steps you’ll take to open your CD account.
- Certificates of deposit (CDs) pay a guaranteed interest rate for a specific length of time.
- Terms often range from three months to five years or more, but early withdrawal penalties may apply if you pull out before the term is up.
- Opening a CD account is similar to opening any other bank account, although you need to choose a CD term and an amount to invest.
- You can buy CDs at banks, credit unions, and brokerage houses. In some cases, you can use CDs inside of an IRA.
What Is a CD Account?
A certificate of deposit (CD) is a bank or credit union account that pays a set rate of interest for a specific length of time. When you have money that you don’t need to spend right away, you can put the funds in a CD for safekeeping and interest earnings.
CDs are time deposits that typically last from three months to five years, but longer-term CDs exist. As you choose among CD options, consider when you might need to spend the money and how much extra you earn by locking up your cash.
CDs often pay higher rates than liquid accounts like savings accounts. That’s because you commit to leaving your funds inside of the CD for an extended period. What’s more, the longer the CD’s term, the higher the rate (in most cases). So an 18-month CD would likely pay a higher rate than a 6-month CD.
If you pull money out of a CD before the term ends, your bank or credit union may charge an early withdrawal penalty. Those fees can wipe out your earnings, and they may even eat into your original investment. Because of that, it’s critical to keep emergency savings in a liquid account, like a savings account, and use CDs only when you’re confident you can leave the money untouched.
Some CDs do not charge early withdrawal penalties. With those products, you can virtually take money out immediately after buying a CD. While the flexibility may be appealing, it’s important to understand the trade-offs. These so-called liquid CDs sometimes offer lower interest rates because you have less skin in the game—you have the option to remove funds at any time. But that may be a compromise you’re willing to make if you value easy access to your funds.
A CD “matures” when it reaches the end of its term. At that point, you have several options:
- Withdraw your funds penalty-free.
- Choose a different CD.
- Let your bank reinvest your money in another CD.
In many cases, you have about 10 days to provide instructions to your bank. If you do nothing, banks often reinvest your money into a new CD with the same maturity as your last CD.
CDs are relatively safe investments. When you use a bank or credit union with government-backed deposit insurance, there’s little risk of losing your money as long as you stay below the maximum limits. Banks offer FDIC insurance up to $250,000 per depositor per bank, and credit unions have equivalent coverage through the NCUSIF.
How To Open a CD Account
Opening a CD account is similar to opening a new bank account. You can often complete the process online, by phone, or in person.
Choose a CD Type
Decide what type of CD works best for you based on whether you want a traditional CD with minimal features or newer variations on the theme. For example, if you might need to withdraw funds early, a CD with no early withdrawal penalties could be ideal. Alternatively, some CDs offer the ability to get a higher rate if interest rates rise, so research those options if you’re concerned about rising rates.
Choose a CD Term
The right CD term depends on how much you want to earn and when you need money. If you have a specific goal in mind for your funds (paying for a child’s education, for example), pick a term that ends a few weeks or months before you need to withdraw funds.
You don’t necessarily have to pick one maturity. It may make sense to use a laddering strategy to prevent locking up all of your money in a single product when rates are at their lowest or when you think they might rise. With a CD ladder, you buy multiple CDs with different terms, and they mature at regular intervals. For example, if you have $4,000 to work with, you might put:
- $1,000 into a one-year CD
- $1,000 into a two-year CD
- $1,000 into a three-year CD
- $1,000 into a four-year CD
Whenever one CD matures, you buy a new four-year CD. With this approach, a CD matures every year, allowing you to use the funds or reinvest at current rates.
Choose a Financial Institution
Some banks and credit unions are more competitive than others. If you’re going to invest a significant amount for an extended period, it’s worth shopping around. Compare online banks, local banks and credit unions, and any institutions where you currently have accounts for the best CD rates available.
Be cautious about where you click when researching banks online. Con artists use misleading ads to draw victims to impostor websites with the goal of stealing your money. Research banks and credit unions before opening an account, and always triple-check to be sure you’re on a legitimate website.
Decide How To Receive Interest
When you open a CD, you can choose to have the interest earnings paid out (so you can spend the money) or held inside the CD until maturity. Payments can go to another account, such as your checking account, and they are often available monthly, quarterly, or annually. However, to maximize your earnings, it’s usually best to leave the funds inside of the CD and take advantage of compound interest.
Open the Account
To open a CD account, you’ll submit an application, which you can often do online or through your bank’s mobile app. You’ll need to provide personal details, such as your physical address and Social Security Number, and your bank may ask for additional information to verify your identity and fund your account.
Fund the Account
Add money to your CD by depositing or transferring funds from another account. You might be able to move money from a different bank or simply shift funds from a checking or savings account within the same bank.
Take note of any minimum balance requirements to buy a CD. Some banks require you to open CDs with a minimum of $2,500 or more, while others have no minimums. If you have a substantial amount of money, research banks and credit unions that reward you for making large deposits. You might qualify for higher rates with a significant account balance.
Frequently Asked Questions (FAQs)
In what situations is a CD the best choice?
CDs may be appropriate when you don’t need your money for at least several months and you want to keep funds safe. Terms typically range from three months to five years, but some last longer. Your money is protected in banks and credit unions that have federal deposit insurance as long as you keep account balances below FDIC and NCUSIF deposit insurance limits.
What is an IRA CD?
An IRA CD is a CD that you buy through a traditional or Roth IRA. You can buy CDs in IRAs through a bank, credit union, or brokerage account. Doing so combines the tax treatment of an IRA with the CD features described above.
How can you earn high interest rates with a CD?
Compare offerings from multiple banks to earn the best rates. Consider online banks, local banks, and local credit unions, as these institutions might pay more than big banks. Large account balances can also help you qualify for higher rates. Finally, longer-term CDs typically pay more than short-term CDs—but if rates rise, you might get stuck with a low rate for an extended period.