Types of CDs
Financial institutions offer a wide range of CDs to fit different financial situations. Take time to consider which type of CD is best for you.
Traditional CDs
Traditional CDs are the most common and have a fixed APY for the CD’s term.
These CDs usually don't let you deposit additional funds before the CD matures. They also tend to have strict early withdrawal penalties.
When this CD makes sense: You know exactly when you need the money and there’s no chance you need it before. Great for CD ladders or another CD investing strategy where timing is important.
No-penalty CDs
Traditionally, CDs are known as time deposit accounts. Standard CDs typically come with early withdrawal penalties: If you withdraw from a CD before it matures, you’ll usually incur a penalty that’s equal to a certain amount of interest earned during a period of time. For instance, a bank may impose a penalty of 90 days of simple interest on a one-year CD if you withdraw from that CD earlier than a year. However, some banks offer no-penalty CDs — also known as liquid CDs — which allow you to withdraw your money early without having a penalty fee cut into your interest earnings. A bank may require that you wait at least some time, generally around six or seven days, before you’re able to withdraw from a no-penalty CD. If the institution lets you withdraw money during that time period, you may incur a penalty. Some banks may not allow a partial withdrawal from your no-penalty CD. Generally, you aren’t able to add to no-penalty CDs. No-penalty CD rates tend to be lower than regular CDs but can be higher than some high-yield savings accounts or money market accounts.
When this CD makes sense: You’re mostly confident that you won’t have to withdraw the money before the CD matures, but you might have to tap it. You’re willing to give up a little return for a flexible withdrawal.
Jumbo CDs
Jumbo CDs generally require savers to deposit $100,000 or more. The phrase “jumbo CDs” isn’t that common these days. But some banks still offer them. Generally, you can find the same or even higher APYs in CD products that aren’t considered jumbo CDs. But some jumbo CDs reward customers for these large deposits with a higher yield.
When this CD makes sense: A jumbo CD is a good option if you can get a little extra yield for depositing more money and you’re sure you won’t need to access your money during the term of the CD.
Brokered CDs
CDs sold through brokerage firms are known as brokered CDs. You need a brokerage account with an institution in order to qualify for one of these certificates of deposit. Brokered CDs sometimes carry higher rates than traditional CDs from your local bank, but they also carry more risk. That's because they can be traded like bonds, and if you decide to sell before the maturity date, you could end up taking a loss. You’ll want to verify these banks are FDIC-insured.
When this CD makes sense: You can get a somewhat higher yield by being able to sit through the ups and downs of the market. A brokered CD is a good option if you’re sure you won’t need to touch the principal before it matures, therefore avoiding the risk that you’ll take out the money when the CD dips.
Callable CDs
Callable CDs carry more risk than traditional CDs, but they tend to offer higher interest rates. The risk is that the bank issuing the CD can "call" your CD before it fully matures, limiting the amount of interest you might earn. For example, if you purchase a three-year CD with a six-month call-protection period, the financial institution could call the CD back after the first six months. You will get your full principal and interest earned; however, you would need to reinvest your money, likely at lower rates.
When this CD makes sense: If rates are not expected to fall further over the life of the CD, a callable CD could make sense. Otherwise, if rates dip significantly outside the call protection period, the bank will likely call in its CD.
Bump-up CDs
These types of CDs allow you to request that the bank increase your rate during the CD term under certain conditions. Institutions that issue this CD option usually only allow one bump-up per term. For example, imagine purchasing a three-year CD at a given rate, and one year into the term, the bank offers an additional half-point rate increase. With a bump-up CD, you're allowed to request a rate increase for the remainder of the term. The disadvantage is that bump-up CDs often pay lower initial rates than traditional CDs. But bump-up CDs can be useful tools in certain environments.
When this CD makes sense: A bump-up CD could be a good option if rates are expected to rise significantly during the term of the CD. Otherwise, you’re likely accepting a lower rate for little potential upside.
Step-up CDs
Like bump-up CDs, step-up CDs give you the opportunity to move up to a higher yield if rates rise. The difference is that with step-up CDs, banks automatically increase rates in the CD at certain intervals. You don't have to request a rate increase. Like with bump-up CDs, the disadvantage is that you'll generally get a lower initial rate. There's also no certainty that you would end up with a better return than if you had parked your savings in a traditional CD with a higher yield instead.
When this CD makes sense: A step-up CD may be a good option if rates are expected to move up substantially during the term of the CD. However, this rise may already be priced into a traditional CD, so it may be simpler and more rewarding to go with a traditional CD from the start.
Add-on CDs
Generally, CDs allow you to only make a single initial deposit. That's not the case with add-on CDs. These products give you the option to make multiple deposits during the term. The exact number of additional deposits you can make varies by institution.
When this CD makes sense: An add-on CD could be a good choice if you’re likely to have more money to add to the account and you’re getting a good rate from it. If rates are likely to rise, however, you could simply add new money to another higher-yielding CD.
Zero-coupon CDs
Zero-coupon CDs allow you to buy the CD at a discount to its value. When the CD matures, you receive the full value of the CD. In this way, they are similar to zero-coupon bonds. Let's say you purchase a $20,000 zero-coupon CD for $10,000. You won't receive interest payments during the term. Instead, you get $20,000 when the CD matures in addition to the accrued interest in a lump sum. These are typically long-term investments, making them ill-suited to those who are seeking a short-term timeline.
When this CD makes sense: You’re able to lock up your money for the term and don’t need to access it at all.
IRA CDs
An IRA CD is a CD that's held inside an individual retirement account. These types of CDs offer guaranteed returns. And traditional IRAs are tax-deferred accounts, which means you don't pay taxes on earnings until you withdraw the money. However, you won’t get rich on these investments as the return potential on cash historically has been lower than stocks and bonds.
When this CD makes sense: You have an IRA and need a risk-free option for your money that still earns some yield. This could be an option if you need to hold cash in your account, for example, as you approach retirement and need to reduce your overall portfolio risk.
Should you open a CD for your child?
Whether you should open a CD for your child depends on when the money is going to be used. If you won’t need the money for a set amount of time, a CD could be a great way to grow your child’s savings. If the goal is to earn a fixed APY, that would also be a reason to consider a CD. However, if this is money that you’re looking to gain a potentially higher rate of return, you may want to look at investment options. But these potential gains could risk principal, so it all depends on what the money is being used for, your time horizon for the money and whether you want a guaranteed rate of return or a riskier investment. If it’s unclear when your child might need the money, consider a savings account or money market account.
What you can and can't do with a CD
You can typically earn a higher APY with a CD than most savings accounts or money market accounts. That interest is usually compounded on a daily, monthly, quarterly or annual basis. It is usually credited to your account on a monthly, quarterly, semiannual or annual basis. You can re-evaluate the CD after the term expires. You usually have a grace period between the CD’s maturity date and renewal date. This allows you to renew it, change the terms or withdraw and close it. You usually can’t add money to CDs until they mature. In most cases, you can withdraw from a CD at any time, but this may result in an early withdrawal penalty. So this is something to avoid, if possible.
CDs and taxes
Are you taxed on a CD when it matures?
Yes, you will be taxed on the interest earned on a CD that contains non-qualified money – money that you already paid income tax on. However, if the money is in a traditional IRA CD, you will pay taxes when the money is withdrawn. This is because traditional IRAs are tax-deferred accounts.
In some cases, you can deduct your CD on your taxes. If you’re eligible to contribute to a traditional IRA CD, you may be eligible for a full deduction up to your contribution limit or a partial deduction. Your modified adjusted gross income, your marital status and whether you’re covered by a retirement plan at work are some of the factors that will determine if you’re eligible for an IRA deduction.
Does cashing a CD count as income?
Interest earned from CDs is an example of taxable interest, according to the Internal Revenue Service. When you earn $10 of interest or more, you should receive Copy B of Form 1099-INT or Form 1099-OID. Even if you don’t receive a 1099, all taxable and tax-exempt interest must be reported on your federal income tax return. Also, interest may be called dividends.
If your CD is a regular bank CD that you opened using funds that have already been taxed, the return of principal shouldn’t be taxed again, Easy Life Management’s Ivanovich says.
One exception to this would be, for instance, if the funds were rolled over from a 401(k) into a traditional IRA CD and those funds have never been taxed. If you’re withdrawing from a traditional IRA CD in that situation, the money that you withdraw will count as income.
What causes CD rates to rise?
The yields on Treasurys, competition among banks, eagerness to secure deposits and the ability to lend money for a higher rate are some factors that cause CD rates to increase. So, if Treasury yields rise, it’s likely that some banks may raise rates.
“Banks take the deposits that we give them and lend them back out,” Stockton says. “So, to the extent that banks can get better returns on lending the money out for a longer duration, they can offer better rates to consumers on CDs for locking in their money for a longer duration."
Do CD rates differ by state?
Generally, online banks tend to keep rates consistent across states. If a bank has a brick-and-mortar location in a certain state, it may not offer an online account in that state.
“Most of the purely online banks offer the same rates across the country,” Stockton says. “With that said, there are certainly some banks who will do promotions from time to time or have a special (offer) locally.”
It’s possible for a bank to have different rates in different markets because different markets have different competitive conditions, Stockton says.
“All of the community banks and credit unions are typically different in different markets,” Stockton says. “And so banks overall have to compete with whoever's in each of their local markets. So it may make more sense to have a higher rate in some markets where they're competing against some really aggressive community banks or credit unions that maybe aren’t in their other market.”