Though the certificate of deposit, or CD, may seem like a generic and straightforward savings account, there's more diversity to this financial tool than may immediately meet the eye. CDs can be particularly useful when interest rates are on the rise, and there's a lot to like about earning a fixed interest rate over time. Balancing out the appeal of CDs' predictability and security, however, is a major tradeoff: Your deposit is locked up for a set period of time, and an early withdrawal will subject you to fees.
Depositing money in a CD will usually generate earn more interest than a savings account -- even a high-yield savings account -- or money market account. And there are plenty of types of CDs to choose from. Read on for an overview of them all.
What is a CD?
A CD is a type of savings account that pays a fixed interest rate for a fixed term. The main difference between a CD and a savings account or money market account is that you can't take your money out of a CD until it has been in the account for a set amount of time, called a term. Common terms include three, six, nine and 18 months as well as one, two, three, four and five years.
Typically, the longer you leave your money untouched in a CD, the more interest you will earn. CDs are insured by the FDIC up to $250,000 if taken out of a federally insured credit union or bank. CDs don't have monthly fees, but most have an early withdrawal penalty.
To open a traditional CD, you make a one-time deposit, then leave the funds to grow until the CD matures for a specific term at a fixed interest rate. Once the CD matures or reaches the end of the term, you can roll your CD into another term or cash out. One of the major downsides to a CD is early withdrawal penalties. If you pull out your cash before it matures, you can face a hefty penalty that can make any interest earned appear nonexistent.
Some CDs are structured so that the issuer can close the CD before its maturity date. This type of CD is called a callable CD. You generally want to invest in a CD that is not callable because it protects your money from being taken back by the issuer. But if you're investing in a callable CD and the bank does redeem it before it has reached maturity, you'll still receive your full principal and the interest it has earned to date.
However, you may be most at risk of the bank taking back your CD early if interest rates suddenly drop. Callable CDs are still rare and may be harder to find than traditional CDs. The callable feature can only be enacted by the issuer.
An IRA CD is held in a tax-advantaged individual retirement account to help you save money for retirement. An IRA CD works much like a traditional CD but there are a couple of notable differences, including how much you can invest and withdrawal penalties.
When it comes to a traditional CD, you can deposit any amount of money in a CD account, lock it up for a predetermined length of time and earn a higher return on your investment than you would with a savings or checking account.
However, your IRA CD is a tax-advantaged retirement account, which means you can save and invest your money in several different ways. Since an IRA CD is partly an IRA, you will have the same rules and requirements as other IRA accounts, such as the amount you can contribute. Individuals under 50 can contribute up to $6,000 and individuals over 50 can contribute up to $7,000.
If you try to withdraw money from a traditional CD before it matures, you will inevitably face an early withdrawal penalty. However, if you try to withdraw early from your IRA CD, you will face a penalty from your bank and the IRS.
Foreign currency CD
A foreign currency CD is held in another country's currency. You might want a foreign currency CD if you think the dollar will decline against other currencies. Or, you may want to invest in other currencies because they are expected to go up against the dollar. With a foreign CD, the money is converted into another currency for the term; the funds earn interest in that currency, and the money is converted back to dollars at the maturity date.
A brokered CD is bought and sold on the secondary market through a brokerage account. These time-deposit savings products are similar to traditional CDs, but they are more liquid because they are traded like bonds.
A zero-coupon CD doesn't make periodic interest payments like a traditional CD at a fixed rate. Instead, it's sold at a discount from its face value, which equals its value once it reaches maturity. The CD holder only receives the face value of the CD when it matures. These are typically long-term investments, meaning you won't get access to the interest earned until the CD matures.
A jumbo CD requires a minimum deposit of about $100,000. A $95,000 CD may be technically a "jumbo CD," but it might not earn as much as a $105,000 CD. Jumbo CDs -- and super jumbo CDs, which require a minimum investment of $250,000 or more -- often pay higher interest rates than regular CDs. But in the current near-zero interest rate environment, jumbo CDs are not earning significantly higher yields than regular CDs.
A bump-up CD allows the depositor to request an increase in the interest rate. If the interest rates of CDs rise, the depositor can request that their existing certificate of deposit be "bumped up" to the new interest rate -- as long as the rates offered by the bank for the specific bump-up CD also rise. Banks typically allow one bump-up per term.
Just as the name suggests, an add-on CD allows money to be added to the account balance after the initial deposit. Money is deposited at the beginning of the term, and then additional deposits are permitted throughout the term. The interest rate remains the same even when money is added, and there are no monthly fees, but there is usually an early withdrawal penalty when money is removed.
With a step-up CD, you can lock in an interest rate for a set number of months, but a predefined rate increase will happen automatically on scheduled dates. Like other CD accounts, there are no monthly fees but early withdrawals are subject to a penalty.
A liquid CD does not charge a penalty for early withdrawals, making it more like a savings account than a standard CD. Like a combination savings account/CD hybrid account, you can withdraw the funds in a liquid CD at any time by contacting the bank, credit union or other financial institution where you bought the CD. But this privilege may come at a cost. Liquid CDs typically pay a lower interest rate than other types of CDs because they allow penalty-free access to the funds.
First, you generally can only make one penalty-free withdrawal. After that, you'll likely face the same early withdrawal penalty as with a traditional CD. Second, some sellers place a limit on how much you can withdraw from a liquid CD at one time -- before penalties kick in, so be sure to always read the fine print.
A high-yield CD, which may also be called a high-interest CD or high-earning CD, is a type of CD that can pay a higher interest rate than a standard savings account. But the amount of interest you earn varies over time -- as interest rates fluctuate -- unlike a fixed-rate CD. High-yield CDs are generally found at online banks and credit unions, which may offer you slightly higher yields to win your business.