A time deposit is a type of bank account with a specific maturity date or term. It’s also interest-bearing. Let’s take a closer look at what a time deposit is and how it works. In addition, you’ll learn the pros and cons of time deposits and a few alternatives to consider.
Definition and Examples of Time Deposits
A time deposit is an interest-bearing bank account that has a set maturity date or term on it. To earn the stated interest rate in a time deposit, you must keep your money in the account for a fixed term. A certificate of deposit (CD) is the most common type of time deposit. If you take out a CD, you promise that you won’t touch the money you invest for a set period of time. This may be anywhere from a few months to a few years. When you redeem the amount you initially put in, you receive the money originally invested plus interest.
You can purchase a CD or another type of time deposit at any financial institution. Since interest rates and terms vary widely, it’s well worth your time to shop around. Fortunately, most banks, credit unions, and other financial institutions post their rates on their websites.
- Alternate name: term deposit
How Do Time Deposits Work?
Once you commit to a time deposit, you let the financial institution use your money for a fixed term. It’ll reward you with a higher interest rate than you’d be able to get with a traditional savings or money market account. In most cases, the longer term you choose, the higher interest rate you’ll receive.
Time deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. This cap is per investment, covering all accounts in your name at the same bank.
You’ll get to choose your term length or how long you wish to give your money to the bank, credit union, or other financial institution. You’ll then deposit a minimum amount. Once your term comes to an end, you can withdraw the money. In the event you’d like to access the funds sooner, you’ll likely have to pay an early withdrawal penalty.
CDs are often considered a low-risk method to save for financial goals, whether those are short- or long-term goals. To further illustrate how time deposits work, let’s look at an example of a CD. Let’s say you want to accumulate a small fund for an anniversary vacation in five years. You invest $5,000 in a five-year CD with a 0.50% annual percentage yield (APY). When the five years are up, you’ll earn about $125 in interest, giving you a total of $5,125.
To make the most out of a CD, you may consider creating a CD ladder through your bank. This spreads a lump sum of money across several CDs with varying maturity dates. With this strategy, you can secure high APYs across multiple CDs, rather than lump all your money into one.
Pros and Cons of Time Deposits
- Greater returns than savings accounts
- Predictable returns
- FDIC insured
- Can get higher returns elsewhere
- Limited liquidity
- Tax liability
- Greater returns than savings accounts: You can earn more interest with a time deposit than a traditional savings account. This is because you agree to keep your money tied up for a set period of time, increasing the interest on an annual basis.
- Predictable returns: If you opt for a time deposit, you’ll know exactly how much you’ll yield and when you’ll do so. The predictable return can make it easier for you to achieve a specific financial goal.
- FDIC insured: Time deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to the $250,000 legal limit. This means that your money will be protected if the financial institution fails.
- Limited liquidity: If you need the money in your time deposit account to cover an unexpected expense, it will be difficult to access it. When putting funds into a CD, it is essentially under lock and key. By withdrawing funds early, you will lose some or all of the expected interest and may be required to pay penalty fees.
- Can get higher returns elsewhere: Compared to stocks and ETFs, time deposits offer relatively low returns. You may be able to earn more money by investing in higher-risk vehicles, but as the name suggests, there is more risk involved if you go this route.
- Tax liability: You have to pay tax annually on any interest your time deposit accrues. This can significantly cut into your earnings.
What It Means for Individual Savers and Investors
A time deposit may be a great way to meet a financial goal. Whether you want to buy your first house, remodel your kitchen, or take a dream vacation, it can help. While a 401(k) and Roth IRA may be ideal options for saving for retirement as they tend to offer higher returns, time deposits can assist with shorter-term financial priorities.
Time deposits are a particularly good option if you don’t want to tie up all your money in riskier products like stocks and bonds. You can think of them as safe investment vehicles that complement your portfolio and give you some peace of mind.
How To Get Time Deposits
The financial institution you use for a checking account may offer time deposits, so it’s a good idea to check with them first. You can also use a brokerage firm to shop around and look for time deposits at various banks, credit unions, and online lenders.
No matter which option you choose, be sure to compare terms, interest rates, and options. Typically, details regarding the withdrawal penalty can be found in the fine print of the time deposit offering. Also, consider what you’d like to do with the money you earn in the time deposit. This way, you can choose the best account for your unique situation and goals.
Alternatives to Time Deposits
If you decide that time deposits aren’t right for you, consider these alternatives.
A dividend is a portion of a company’s profit that is paid to shareholders. While risky, this investment can provide you with a modest income and comes with the potential for longer-term capital appreciation. As a shareholder in a high-dividend stock, you’ll likely be able to earn a higher yield than you would with a time deposit.
Short-Term Bond Funds
This is a fund that invests in bonds with maturities younger than five years. Short-term bond funds have similar terms and offer liquidity plus a higher yield. However, be aware that they’re subject to both interest rate and credit risk. There is no guarantee that you will see at least the amount of money you initially put into the fund.
- A time deposit, like a certificate of deposit, is a type of bank account with a specific maturity date or term.
- While it’s less riskier than stocks, bonds, and other investment vehicles, it offers a lower rate of return.
- You can use a time deposit to save for a specific financial goal such as buying a house or taking a dream vacation.