What a CD is and how it works

A certificate of deposit (CD) is an account where you give a bank a sum of money for a fixed period of time—usually anywhere from three months to five years—in exchange for a may provide interest rate. You cannot touch that money without penalty until the term ends. When the term is up, the bank returns your original deposit plus the interest you earned.

The trade-off is simple: you give up access to your cash, and the bank gives you a higher interest rate than you would get in a regular savings account. The bank uses your money during that time, which is why they pay you more for letting them keep it locked up.

CDs are FDIC-insured at most banks, meaning if the bank fails, the federal government guarantees your deposit up to $250,000. 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 lump sum and agree not to withdraw it for a set term—three months to five years is typical—in exchange for a fixed interest rate.
  • The interest rate on a CD is locked in when you open it and does not change, even if the bank raises rates later.
  • Withdrawing money before the term ends triggers an early withdrawal penalty, usually a few months of interest.
  • 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.
  • CDs are FDIC-insured up to $250,000, making them a low-risk way to save money you do not need right away.

How the interest rate is set and locked in

When you open a CD, the bank tells you the annual percentage yield (APY)—the exact rate you will earn. That rate is locked in for the entire term. If the bank raises its CD rates next month, your rate stays the same. If rates fall, you still get the rate you signed up for.

Different banks offer different rates, and rates change based on what the Federal Reserve does with interest rates. Online banks typically offer higher CD rates than brick-and-mortar banks because they have lower overhead costs. The longer the term, the rate is usually higher—a five-year CD pays more than a one-year CD—because you are giving the bank your money for longer.

The interest compounds, meaning you earn interest on your interest. How often it compounds (daily, monthly, or quarterly) depends on the bank's terms. More frequent compounding means slightly more money at the end, though the difference is usually small.

What happens if you need the money early

If you withdraw money before your CD matures, you pay an early withdrawal penalty. This penalty is usually a set number of months of interest—for example, three months of interest on a one-year CD, or six months on a longer term. Some banks calculate it differently, so always ask what the penalty is before you open the account.

The penalty comes out of your interest earnings first. If you have earned less interest than the penalty costs, the bank takes the difference from your principal. This means you could get back less money than you put in if you withdraw very early.

A few banks offer "no-penalty CDs" where you can withdraw without a penalty, but these come with a lower interest rate to compensate. They are worth considering if you think you might need the money but want a may provide rate.

When your CD reaches maturity

On the maturity date—the day your term ends—you have three choices. You can withdraw the full amount (principal plus interest). You can open a new CD with the same bank or a different one. Or you can let the CD automatically roll over into a new term at the bank's current rate.

Most banks will automatically roll over your CD if you do not tell them otherwise. The new rate will be whatever the bank is offering at that moment, which could be higher or lower than what you had. Banks are required to give you a grace period (usually seven to ten days) after maturity to withdraw or change your mind about rolling over, so you have time to shop around if you want.

If you do nothing and the bank rolls your CD over, you are locked in again for another full term. Read any maturity notices the bank sends you so you know when your CD is about to mature and what will happen if you do not act.

CD ladders and how they work

A CD ladder is a strategy where you open multiple CDs with different maturity dates instead of putting all your money in one CD. For example, you might open five one-year CDs, each with $1,000, but stagger them so one matures every few months.

The advantage is that you get regular access to portions of your money without paying early withdrawal penalties. As each CD matures, you can withdraw that money or roll it into a new CD at the current rate. This gives you some flexibility while still locking in higher rates than a savings account offers.

A ladder also protects you if rates are rising. If you put all your money in a five-year CD and rates jump the next month, you are stuck with the old rate. With a ladder, only part of your money is locked in at the old rate, and the rest matures soon enough to take advantage of higher rates.

How CD rates compare to other savings accounts

CDs almost always pay more than a regular savings account at the same bank. A typical savings account might pay 0.01% APY, while a one-year CD at the same bank might pay 4% or 5% (rates vary by bank and change over time). The longer you lock your money away, the higher the rate usually goes.

Money market accounts sometimes pay rates close to CDs, but they usually come with check-writing or debit card access, which means you can withdraw whenever you want. That flexibility costs you—the rate is typically lower than a CD for the same term.

High-yield savings accounts have become more competitive in recent years and can sometimes match or nearly match short-term CD rates, but without the penalty for withdrawal. The trade-off is that savings account rates can change at any time, while your CD rate is locked in.

Tax treatment of CD interest

The interest you earn on a CD is taxable income. The bank will send you a 1099-INT form at the end of the year showing how much interest you earned, and you report that on your tax return. You owe federal income tax on the interest, and possibly state income tax depending on where you live.

This matters most for longer-term CDs. If you open a five-year CD and earn $500 in interest, you do not pay tax on all $500 at once—you pay tax each year on the interest earned that year, even though you cannot access the money yet. Some people open CDs in retirement accounts (like an IRA) to defer or avoid this tax, though that comes with its own rules.

Frequently Asked Questions

Can I move my CD to a different bank before it matures?

Not without paying the early withdrawal penalty. You own the CD at the bank where you opened it, and moving it means closing it early. Some banks will waive the penalty if you move to them, so it is worth asking, but there is no standard rule.

What if interest rates drop after I open my CD?

Your rate stays the same—that is the whole point of locking it in. You keep earning the rate you agreed to, even if the bank is now offering lower rates to new customers. This is one of the main reasons people open CDs when rates are high.

Do I have to put a minimum amount of money in a CD?

Most banks require a minimum deposit to open a CD, often $500 or $1,000, though some online banks have lower minimums or none at all. Check the specific bank's requirements before you open an account.

What happens to my CD if the bank fails?

Your CD is protected by FDIC insurance up to $250,000. If the bank fails, the FDIC will pay you your principal plus any interest earned up to the maturity date, even if the bank no longer exists. This protection applies to each depositor at each bank separately.

Can I add more money to my CD after I open it?

No. A CD is a fixed contract—you deposit a set amount at the start, and that amount stays the same until maturity. If you want to save more, you would open a separate CD or use a savings account.