CDs can have higher rates than standard savings accounts, but your cash isn’t as accessible.

What is a CD?

Definition: A certificate of deposit, or CD, is a type of federally insured savings account that has a fixed interest rate and fixed date of withdrawal, known as the maturity date. CDs also typically don’t have monthly fees.

Share certificates, which are the credit union version of CDs, are also low risk, as they’re insured up to the same amount through the National Credit Union Administration.

A CD is different from a traditional savings account in several ways.

  • Savings accounts let you deposit and withdraw funds relatively freely. But with a CD, you typically agree to leave your money in the bank for a set amount of time, called the term length, during which time you can’t access the funds without paying a penalty.
  • Term lengths can be as short as a few days or as long as a decade, but the standard range of options is between three months and five years.

The longer the term length — the longer you commit to keeping your money in the account and thus with the bank — the higher the interest rate you’ll earn. Some of the best five-year CDs have rates above 2.20% APY.

Most CDs come with fixed rates, meaning annual percentage yields are locked in for the duration of the term. There are a few exceptions that we will explore below.

Why you might benefit from a CD

Higher rates than regular savings accounts usually. CDs can pay off for folks who are certain that they won’t need access to that cash during the duration of the term length. A five-year CD with a 2.20% APY — among the highest rates you’ll find — will earn around $575 on a $5,000 deposit. Keep the same amount in a savings account that earns a top-notch rate of 1.80%, and you’d earn around $460 after five years. (And either option pays more than a five-year CD with a rate at or below the national average of 0.70% annual percentage yield, according to the Federal Deposit Insurance Corp.[1])

Opening a CD with one of the best rates might mean joining a bank or credit union outside of your primary financial institution. Not sure if it’s worth the hassle? It’s a more popular move than you might think: 45% of banking consumers have accounts with two or more financial institutions, according to a 2018 Mintel report.[2]

Besides the five-year CD, another route is to go for high-yield three-month, six-month or one-year CDs, which might work better if you’d rather wait months instead of years for access to your funds.

When to stick with a savings account

For more access to your money, without an early withdrawal penalty. If you end your commitment early by withdrawing the money before the CD matures, you’ll likely be charged a penalty. It varies, but typically you’ll give up several months’ to a year’s worth of interest accrued.

Take note of any such penalty on a CD before choosing to withdraw early. FDIC and NCUA insurance doesn’t cover penalties incurred by withdrawing money early. If there’s a chance you’ll need that cash to cover an emergency, skip the CD and stick with a high-yield savings account.

Specialty CDs: Other types of CDs

CDs typically come with a fixed term and a fixed rate of return. But depending on where you bank, you may have access to a few other varieties.

  • No-penalty CD: This CD, also known as a “liquid CD,” lets you withdraw early without an early withdrawal penalty in exchange for typically lower rates than other CDs.
  • High-yield CD: This CD has higher-than-average CD rates. Online banks and credit unions typically offer better rates than traditional brick-and-mortar banks.
  • Jumbo CD: This is essentially the same as a regular CD but with a high minimum balance requirement — upward of $100,000 — as a trade-off for higher rates.
  • IRA CD: This is a regular certificate that is held in a tax-advantaged individual retirement account.
  • Bump-up CD: With these CDs, you can request a higher rate if your bank increases its APYs. These CDs typically have lower interest rates than fixed-rate CDs, and some carry steeper minimum deposit requirements. In most cases, you can request only one rate increase, although long-term CDs may let you do so twice.
  • Step-up CD: This option provides more predictable rate increases set by the bank, where APYs automatically go up at regular intervals. For example, rates on a 28-month step-up CD might go up every seven months.
  • Brokered CD: This is a CD offered at a third party, or broker, such as a brokerage firm.

CD ladders provide flexibility

Some savers might want the higher rates of a three- to five-year certificate but are wary of tying up their money for such a long time. That’s where “laddering” can come in handy. You invest proportionally in a variety of term lengths. Then, as each shorter certificate matures, you reinvest the proceeds in a new long-term CD. (To compare short-term options, see our list of the best one-year CDs. Or if you’re building a longer ladder, see three-year CDs.)

Say you have $10,000. With that cash you invest $2,000 apiece in one-, two-, three-, four- and five-year CDs. When the shortest-term certificate matures after one year, you put that money into a new five-year CD. The next year, you reinvest the funds from the matured two-year certificate in another five-year CD. Repeat the process until you have a five-year CD maturing every year. At that point, you’ll have the flexibility of cashing out one certificate a year without facing early withdrawal penalties.

CDs offer low risk, some reward

Investing in a certificate of deposit isn’t the quickest way to grow your money, but it’s not terribly risky, either. A CD with a good rate can play an important role in your overall savings plan.

By choosing the right type of CD, taking advantage of a laddering strategy and avoiding withdrawal penalties, you can earn a solid return on your money, all while having your savings backed by the federal government.

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