A certificate of deposit is a savings account where you agree to leave money untouched for a set time in exchange for a higher interest rate

When you open a CD, you deposit a lump sum—say $5,000—and the bank locks that money away for a fixed period: three months, six months, one year, five years, or longer. During that time, you cannot withdraw the money without paying a penalty. In return, the bank pays you a higher interest rate than a regular savings account would offer. At the end of the term, you get your original deposit back plus the interest earned.

The trade-off is straightforward: you give up access to your money for a may provide, higher return. A regular savings account lets you withdraw whenever you want but pays almost nothing. A CD pays more but locks your cash away. Banks use your CD money to make loans, so they reward you for letting them keep it.

Key Takeaways

  • You deposit a fixed amount and agree not to touch it for a set period—typically three months to five years—in exchange for a higher interest rate than a savings account offers.
  • If you withdraw money before the term ends, you pay an early withdrawal penalty, which is usually a few months' worth of interest.
  • When the CD matures, you receive your original deposit plus all interest earned, and you can then withdraw the money or roll it into a new CD.
  • CD rates vary by bank and by term length; longer terms usually pay more, but rates change based on what the Federal Reserve does with interest rates.
  • CDs are insured by the FDIC up to $250,000 per depositor per bank, so your money is protected even if the bank fails.

How interest rates and term length work together

The longer you agree to lock your money away, the higher the interest rate the bank will pay you. A three-month CD might pay 4.5 percent annually, while a five-year CD from the same bank might pay 5.2 percent. The bank is willing to pay more because it knows it can use your money for longer without you asking for it back.

Interest rates on CDs move up and down based on what the Federal Reserve does. When the Fed raises its benchmark rate, banks raise CD rates. When the Fed cuts rates, CD rates fall. This means the rate you lock in today is the rate you keep for the entire term—if rates drop next month, you still earn what you agreed to. But if rates rise, you cannot switch to the higher rate without breaking the CD and paying the penalty.

Some banks offer "bump-up" CDs that let you increase your rate once during the term if rates rise, but these usually start at a slightly lower rate than a standard CD. Others offer "no-penalty" CDs that let you withdraw early without a penalty, but they pay less interest to offset that flexibility.

What happens if you need the money before the term ends

If you withdraw money from a CD before maturity, you pay an early withdrawal penalty. The penalty is typically three to six months of interest, though some banks charge more or less. If you withdraw early from a one-year CD earning $200 in interest, a three-month penalty might cost you $50, leaving you with $150 in interest plus your original deposit.

The penalty can sometimes exceed the interest you have earned, meaning you could end up with less money than you started with. For this reason, only put money into a CD if you are confident you will not need it before the term ends. If you think you might need access to the cash, a high-yield savings account is a safer choice—it pays less interest but lets you withdraw anytime without penalty.

FDIC insurance and safety

CDs held at banks insured by the Federal Deposit Insurance Corporation (FDIC) are protected up to $250,000 per depositor per bank. This means if the bank fails, the FDIC will return your money. If you have $250,000 in a CD at one bank and the bank goes under, you are fully covered. If you have $300,000 at the same bank, only $250,000 is insured.

If you want to insure more than $250,000 in CDs, you can open accounts at different banks—each account is insured separately. You can also open a CD in your name alone and another in joint names with a spouse; each account gets its own $250,000 of coverage. Credit unions offer similar protection through the National Credit Union Administration (NCUA).

Comparing CDs to other savings options

A regular savings account is liquid—you can withdraw money anytime—but pays very little interest, often less than 0.01 percent annually. A high-yield savings account pays more (currently 4 to 5 percent at many online banks) and still lets you withdraw whenever you want, though some banks limit free withdrawals to six per month. A CD pays a competitive rate but locks your money away.

Money market accounts sit between savings and CDs: they pay higher interest than regular savings, let you write checks or make a few withdrawals per month, but do not lock your money away. Treasury bills and bonds are issued by the federal government and are extremely safe, but require a minimum investment and have their own maturity dates and rules.

If you have money you will not need for several years, a CD often makes sense. If you might need the cash within a year or two, a high-yield savings account is usually the better choice. If you want some growth but also want to access your money, a money market account is a middle ground.

How to open a CD and what to watch for

You can open a CD at any bank or credit union. Online banks often pay higher rates than brick-and-mortar banks because they have lower overhead costs. You will need to provide your name, address, Social Security number, and proof of identity. The bank will ask how much you want to deposit and what term you want—three months, one year, five years, and so on.

Before you open a CD, compare rates across several banks. A difference of 0.5 percent might not sound like much, but on a $10,000 CD over one year, it means $50 more in your pocket. Websites like Bankrate and DepositAccounts let you search current CD rates by term and bank. Read the fine print about the early withdrawal penalty—some banks charge more than others, and knowing the penalty helps you decide if the rate is worth the risk.

Also check whether the bank compounds interest daily, monthly, or at maturity. Daily compounding means you earn interest on your interest more often, which adds up slightly over time. Most banks compound daily, but it is worth confirming.

What happens when your CD matures

When the term ends, your CD matures. The bank will notify you a few days or weeks before maturity. At that point, you have several choices: withdraw the money, let it automatically roll into a new CD at the current rate, or move it elsewhere.

If you do nothing, many banks automatically roll your CD into a new one at the same term length and the current rate. This is convenient if you want to keep the money locked away, but the new rate might be lower than what you just earned. Read your maturity notice carefully so you know what will happen if you do not act. If you want to withdraw the money or move it to a different bank, you usually have a grace period of seven to ten days after maturity to do so without penalty.

Frequently Asked Questions

Can I add money to a CD after I open it?

No. A CD is a fixed deposit—you choose the amount when you open it, and that amount stays the same until maturity. If you want to save more, you open a separate CD or use a savings account. Some banks offer "add-on" CDs that let you deposit more during the term, but these are less common.

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

A CD is issued by a bank and insured by the FDIC. A savings bond is issued by the U.S. Treasury and backed by the federal government. Both lock your money away for a set time, but savings bonds have different rules about when you can cash them and how interest is taxed. CDs are simpler for most people.

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 the money. The bank will send you a 1099-INT form at tax time showing how much interest you earned. If you are in a high tax bracket, the after-tax return on a CD might be lower than you expect.

Is a CD a good place to put an emergency fund?

Not usually. An emergency fund should be straightforward to access without penalty. A high-yield savings account is better because you can withdraw the money anytime. A CD is better for money you know you will not need for several years.

What happens if interest rates drop after I buy a CD?

You keep earning the rate you locked in when you opened the CD. This is an advantage—you are protected from rate drops. If rates rise, you cannot switch to the higher rate without breaking the CD and paying the early withdrawal penalty.