What Is a CD Account?

A certificate of deposit (or CD) is a financial product that can be purchased by individuals at banks or credit unions. A CD pays a higher-than-normal interest rate in exchange for the individual leaving their deposit in the account for a specific period of time.

In other words, a CD account is like a locked savings account with a high interest rate.

How Does a CD Account Work?

A CD is a way for you to keep your savings while earning a premium interest rate. The only catch? You can’t touch it for a specific period of time.

The reason a CD is “locked” for the specific duration is that the money you place in the account is being used by the bank or credit union. The bank or credit union rewards you with a higher interest rate for agreeing not to touch the funds (without an early withdrawal penalty).

CD Account Term Lengths

When a CD’s term ends, it has reached maturity. The maturity date is important because it’s when you can have access to the funds again without incurring a penalty. You will also no longer be earning that high-interest rate.

Why Open a CD Account?

CDs are considered a low-risk investment because – just like savings accounts – they are insured. If you get a CD with a bank it’s insured by the FDIC; CDs with a credit union are insured by the NCUA. This means the amount you deposit (up to $250,000) will be safe if the bank or credit union fails.

Because your CD is safe, it’s a great tool to grow a chunk of money for future expenses that are a few years away. For example, you might open a CD if you have $20,000 for your child’s college tuition, but your child is still a few years away from college. You could also open a CD to save your down payment for a future home purchase.

CDs aren’t the best option to save for long-term expenses (like retirement) because, although CDs pay higher interest than a savings account, they earn low returns compared to other investments (due to having virtually no risk). It’s also not a good place for your emergency fund because of its inaccessibility while it matures. In fact, if you have any uncertainty about when you’ll need to access your money, a CD is not the right place for it.

Is a CD Account Right for You?

When considering any financial product, it’s always important to compare the pros and cons before making a decision.

What Are the Advantages of a CD Account?

  • Safe investments because they are federally insured

  • Fixed interest rate delivering predictable returns

  • A wide variety of options at various financial institutions

  • Better interest rates than a regular savings account

  • Multiple options for terms (12 months, 18 months, etc)

What Are the Disadvantages of a CD Account?

  • Inaccessible while maturing (unless you pay an early withdrawal penalty [EWP])

  • The returns are nominal compared to other, riskier investments, such as the stock market

  • You must make a lump sum deposit and cannot keep making contributions

How to Choose the Best CD Account

If you want to open a CD account, do your research. Below are the top 4 things you should know about each CD account you’re considering.

How to choose the best CD account

1. Compare Interest Rates

Typically CD rates are fixed interest rates. This means they stay the same for the duration of the account until it reaches maturity.

You want to get the best interest rate possible. Take your time and shop around to compare what’s available.

2. Review the Term/Duration

The term (or duration) is the length of time you agree to leave your money in the CD without touching it. This is something to seriously consider by looking at your future financial plans. Consider when you might need the funds and let this inform your decision on the CD term.

3. Check the Deposit Requirement

CD accounts require one lump sum deposit, unlike a typical savings or money market account where you can continue to put money in every month. Review your finances and determine how much you plan to deposit into the CD account. Some banks have a minimum deposit requirement to open an account, so review these when you are choosing a CD account.

4. Know the Financial Institution and Fees

The bank or credit union you choose to open the CD account with is important. Take a look at customer service reviews online and, of course, check to see what the EWP is for the CD account.

5 Steps to Open a CD Account

If you were to set up a CD account, these are the steps you should take:

  1. Research CD accounts

  2. Choose a CD account with the best rate and the term that suits your needs

  3. Make the deposit in order to fund the account

  4. Do not touch the money during the term while the CD matures

  5. At the maturity date, regain access to your money (plus the earned interest)

Best CD Account Interest Rates

The best CD rates depend on the term you want. For example, a 1-year CD and a 5-year CD are going to have very different rates. Understandably, the 5-year CD rate will be higher. To get a feel for the average CD rates, you can review the weekly national rates on the FDIC website.

Currently, the best CD account interest rates range from 1.00% for a 1-year CD to around 1.2% to 1.4% for a 5-year CD.

CD vs Savings Accounts

CDs are similar to savings accounts in that they are a safe place to store your money because they are insured. However, the most notable differences are the returns and accessibility.

CDs generally offer a much higher interest rate than a regular savings account (whose average interest rate is .06%).

A savings account is much more accessible through an ATM or branch location and allows for you to make up to 6 transfers per month at most institutions. In contrast, CDs require a lump sum deposit and you can’t access the money before the term ends without a hefty penalty.

In general, a savings account is a good place to keep cash for upcoming expenses like a trip. A CD is a good place to keep a lump sum of cash you are saving for a future purchase, as long as you know you will not need the money before then.

CD vs Money Market Accounts

CDs and money market accounts are both federally insured and usually require higher minimum deposits. They also have comparable interest rates. This might make money market accounts seem immediately more desirable, but the interest rates for a money market account are variable.

This means they can – and most likely will – change in reaction to national averages. Interest rates for a CD are usually fixed for the entire term once you open the account. This means you can have a predictable return on a CD account.

In general, if you have a large sum of money you don’t need to touch (as you already have an emergency fund in place), then you should consider a CD for the fixed interest rate. If you don’t have an emergency fund – or want access to your funds at any time without penalty – then a money market account may be the better choice for you.

The CD Ladder Strategy

CD laddering is a CD investment strategy that is often used by investors when interest rates are on the rise. To create a CD ladder, an investor puts money in multiple CDs with different terms. Over time, the investor reinvests the proceeds from a matured CD into a new, long-term CD.

CD laddering lets you take advantage of higher interest rates by allowing a portion of your money to be accessible at predictable intervals.

CD Ladder Example:

Let's say you have $75,000 you want to use to create a CD ladder. You could start by investing $25,000 in a 1-year CD paying 1%, another $25,000 in a 2-year CD paying 2%, and the final $25,000 in a 3-year CD paying 3%. Each year is considered a "rung" on the CD ladder.

As each CD matures, you would reinvest the proceeds into a three-year CD (or whatever the longest term CD is on your CD ladder). So when the one-year CD matures, you’d invest that money into a new, 3-year CD. At the end of the second year, you would put the proceeds from the matured 2-year CD into a new 3-year CD, and so on up the "ladder."

CD ladder example