How a Certificate of Deposit (CD) Works

A Certificate of Deposit (CD) is a savings product where you agree to leave a chunk of money at a bank or credit union for a set period of time. In return, the bank pays you a higher interest rate than a regular savings account, and the rate is locked in for the whole term. That is the trade — flexibility for a slightly better rate.

This is a plain-English explainer. For a feel for how a CD fits into a savings plan, our saving goals calculator can help you sketch the numbers. For more vocabulary, see interest rate and APR, and the Learn hub for related topics.

How a CD works, step by step

1. You walk into a bank (or open an account online) and pick a term — for example, 6 months, 1 year, 5 years.
2. You deposit a fixed amount of money. Some CDs have a minimum, often $500 or $1,000.
3. The bank gives you a fixed interest rate that is locked for the whole term.
4. The bank pays the interest at the schedule listed on the agreement.
5. At the end (the maturity date), you get your original deposit back plus the interest.

The Federal Deposit Insurance Corporation (FDIC) at fdic.gov explains the basic CD mechanics for bank CDs. Credit union CDs (sometimes called share certificates) work the same way and are insured by the National Credit Union Administration (NCUA) at ncua.gov.

What insurance covers

This is the part most people care about most:

• FDIC insures bank deposits, including CDs, up to $250,000 per depositor, per insured bank, per ownership category.
• NCUA insures credit union deposits with the same $250,000 limit.

If your bank or credit union fails, your CD is covered up to that limit. The FDIC publishes a free Electronic Deposit Insurance Estimator (EDIE) at fdic.gov so you can check your exact coverage.

This is one of the things that makes CDs different from investments — there is no market risk on insured CDs. The trade-off is that returns are modest compared to long-term stock returns.

The early withdrawal penalty

If you take your money out before the maturity date, the bank charges an early withdrawal penalty. The size depends on the term — common patterns:

• 3 months of interest on a CD with a term of 1 year or less.
• 6 months of interest on a 2-year CD.
• 12 months of interest on a 5-year CD.

The Consumer Financial Protection Bureau (CFPB) requires these terms to be in plain English on the disclosure. You can lose some of your principal if the penalty is bigger than the interest you have earned so far. Read the disclosure carefully before signing.

APR vs APY (the two letters that matter)

CD rates are usually quoted as APY (Annual Percentage Yield), not APR. The difference:

• APR (Annual Percentage Rate) — the simple yearly rate, ignoring the effect of compounding.
• APY (Annual Percentage Yield) — what you actually earn after compounding interest is included.

For example, a CD with a 4.91% APR that compounds monthly has an APY of about 5.02%. The Truth in Savings Act, enforced by the CFPB, requires banks to advertise the APY for savings products so you can compare apples to apples.

CD ladders

A CD ladder is a way to spread your money across CDs of different terms so a piece becomes available regularly. For example, with $5,000 you might open:

• $1,000 in a 1-year CD.
• $1,000 in a 2-year CD.
• $1,000 in a 3-year CD.
• $1,000 in a 4-year CD.
• $1,000 in a 5-year CD.

Each year, one CD matures. You can spend the cash if you need it, or roll it into a new 5-year CD at whatever rates exist then. This gives you better rates than putting it all in short CDs while keeping some money accessible every year.

The CFPB and FDIC both have plain-English pages on CD laddering as a savings strategy.

Common CD types

A short tour of variations:

• Traditional fixed-rate CD — the standard. Locks in one rate for the whole term.
• Bump-up CD — lets you raise your rate one time during the term if rates rise. Usually pays a slightly lower starting rate.
• No-penalty CD — lets you withdraw early without a penalty. Usually pays a slightly lower rate.
• Brokered CD — a CD bought through a brokerage. Often higher rates and longer terms, but sold like a bond and may behave differently if you sell before maturity. The SEC at investor.gov has a plain-English page on brokered CDs.
• Jumbo CD — large minimum deposit (often $100,000+) in exchange for a slightly higher rate.

The right one for you depends on your timeline, your tolerance for locked-up money, and what your specific bank offers.

When a CD makes sense

A few common situations the FDIC and CFPB describe:

• You have a chunk of cash you definitely will not need for a known period.
• You want a guaranteed return for that period and you want the FDIC or NCUA insurance.
• You are saving for something with a fixed date — a wedding, a tax bill, a planned purchase.
• You want to lock in a rate you like before rates fall.

A CD is generally a poor fit for your emergency fund, where you might need the cash on a moment's notice. A high-yield savings account or money market account usually fits emergency money better.

How CDs are taxed

Interest from a CD is taxable as ordinary income at the federal level (and usually state level too). The bank sends a 1099-INT every year showing the totals to put on your tax return. CDs held inside a 401(k), IRA, or HSA follow that account's tax rules instead. See IRS Publication 550 at irs.gov.

A note on advice

This is general information, not advice. Whether a CD fits depends on your timeline, your tax situation, and what other savings options exist. A fee-only fiduciary advisor or a non-profit credit counselor (the CFPB lists approved ones) can walk through your real numbers.

Numbers and rules in this article change every year — always check the latest from the SEC's investor.gov, the IRS, and your bank or broker.