A CD locks your money away for a set time in exchange for a higher interest rate

A certificate of deposit (CD) is a savings product where you give a bank a lump sum of money and agree not to touch it for a specific period—usually anywhere from three months to five years. In return, the bank pays you a fixed interest rate that is almost always higher than what you'd earn in a regular savings account. When the time period ends, you get your original money back plus all the interest it earned.

The trade-off is simple: you lose access to your money during the CD term. If you withdraw before the term ends, the bank charges you a early withdrawal penalty, which is a fee that reduces how much interest you actually keep. The longer you agree to lock your money away, the higher the interest rate the bank will offer you.

CDs are one of the safest places to put money because they are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. This means if the bank fails, the government guarantees you get your money back.

Key Takeaways

  • You deposit a fixed amount of money and agree not to withdraw it for a set term, typically three months to five years.
  • The bank pays you a fixed interest rate that does not change, and it is usually higher than a regular savings account rate.
  • If you withdraw money before the term ends, you pay an early withdrawal penalty that reduces your earnings.
  • Your deposit is insured by the FDIC up to $250,000, so your money is protected even if the bank fails.
  • When the term ends, your CD matures and you can withdraw the money or roll it into a new CD.

How the interest rate and term length work together

Banks set CD interest rates based on how long you agree to lock your money away. A three-month CD might pay 4.5 percent annual interest, while a five-year CD from the same bank might pay 5.2 percent. The longer the commitment, the higher the rate—because the bank gets to use your money for a longer period without you being able to ask for it back.

The interest rate you receive is fixed, meaning it does not change during the term. If you open a one-year CD at 5 percent, you will earn 5 percent for the entire year, even if the bank's rates drop to 3 percent next month. This predictability is one reason people choose CDs: you know exactly how much money you will have when the term ends.

Interest on a CD is usually compounded daily or monthly, depending on the bank's terms. Compounding means the interest you earn gets added to your balance, and then you earn interest on that interest. A bank's disclosure document will tell you exactly how often this happens and how the rate is calculated.

What happens when your CD reaches maturity

The day your CD term ends is called the maturity date. On that date, your CD stops earning interest. Most banks give you a grace period—usually five to ten days—during which you can decide what to do with the money without penalty.

You have three main options when a CD matures. First, you can withdraw the entire balance, including all interest earned, and move the money to another account or bank. Second, you can roll the money into a new CD at the bank's current rates. Third, you can do nothing, and many banks will automatically roll your CD into a new term at the current rate if you do not give instructions before the grace period ends. Read your CD agreement to see what your bank does by default.

If you withdraw during the grace period, you receive your full balance with no penalty. If you withdraw after the grace period ends but before the new term is complete, you will pay an early withdrawal penalty on the new CD.

Early withdrawal penalties and how they work

An early withdrawal penalty is a fee you pay if you take money out of a CD before the maturity date. The penalty amount varies by bank and by CD term. A bank might charge you three months of interest on a one-year CD, or it might charge a flat fee like $25. Some banks calculate the penalty as a percentage of your deposit.

The penalty is deducted from your interest earnings first. If you earned $150 in interest and the penalty is $100, you walk away with $50 of your interest plus your original deposit. If the penalty is larger than the interest you have earned so far, the bank takes the difference from your principal—the money you originally deposited.

Because penalties can be steep, many people avoid CDs if they think they might need the money before the term ends. Some banks offer no-penalty CDs that let you withdraw without a fee, but these pay lower interest rates than traditional CDs. The trade-off is always the same: more flexibility costs you in interest earnings.

Different CD types and how they differ

Most banks offer a standard CD, but some offer variations. A bump-up CD lets you increase your interest rate once during the term if rates rise, without having to withdraw and restart. A step-up CD automatically increases your rate at set intervals during the term. These options pay slightly less interest than a standard CD because you get more flexibility.

A no-penalty CD lets you withdraw your money without paying a fee, but the interest rate is lower than a standard CD for the same term. A jumbo CD requires a larger minimum deposit—often $100,000 or more—and usually pays a higher rate in return.

Some banks also offer promotional CDs with higher rates for a limited time, or add-on CDs that let you deposit additional money during the term. Each type has different rules, so you need to read the specific terms before opening one.

How CD interest is taxed

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

One important detail: you owe taxes on the interest in the year you earn it, even if you do not withdraw the money. If you open a one-year CD on January 1 and it matures on December 31, you owe federal income tax on that year's interest when you file your taxes the following spring, even though you have not touched the money yet.

If you are in a high tax bracket, the after-tax return on a CD might be lower than you expect. A CD paying 5 percent interest might net you only 3.5 percent after taxes if you are in the 30 percent tax bracket. This is why some people keep CDs in retirement accounts like IRAs, where the interest grows tax-deferred.

Where to open a CD and what to compare

You can open a CD at any bank or credit union, and rates vary significantly. A large national bank might offer 4.5 percent on a one-year CD, while an online bank might offer 5.3 percent for the same term. Because CD rates change frequently, it pays to shop around before you commit.

When comparing CDs, look at the interest rate, the term length, the minimum deposit required, the early withdrawal penalty amount, and what happens at maturity. Some banks have lower penalties but also lower rates. Others require a larger minimum deposit but pay more interest. There is no single "best" CD—it depends on your situation and how long you can afford to lock the money away.

Make sure any bank you choose is FDIC-insured. You can check this on the FDIC's website by searching for the bank's name. If a bank is not FDIC-insured, your deposit is not protected if the bank fails.

Frequently Asked Questions

Can I withdraw money from a CD before it matures?

Yes, but you will pay an early withdrawal penalty. The penalty amount depends on your bank and the CD term—it might be a flat fee, a percentage of your deposit, or a certain number of months of interest. The penalty is deducted from your balance, so you may lose some or all of your interest earnings.

What is the difference between a CD and a savings account?

A savings account lets you withdraw money anytime without penalty, but it pays a much lower interest rate. A CD locks your money away for a set term and pays higher interest, but you cannot touch it without paying a fee. CDs are better if you have money you will not need for several months or years.

Do I have to pay taxes on CD interest?

Yes. Interest you earn on a CD is taxable income in the year you earn it. The bank sends you a Form 1099-INT at the end of the year, and you report that interest on your federal tax return. You may also owe state and local taxes depending on where you live.

What happens if the bank fails while I have a CD?

Your CD is insured by the FDIC up to $250,000. If the bank fails, the FDIC guarantees you get your full deposit back plus any interest earned up to the maturity date. You do not need to do anything—the FDIC handles it automatically.

Can I move a CD to a different bank?

You can withdraw your CD when it matures and move the money to another bank, but you cannot transfer an active CD without withdrawing it first. If you withdraw before maturity, you pay the early withdrawal penalty. When your CD matures, you can move the money penalty-free during the grace period.