A CD, or certificate of deposit, is one of the safest types of investments because it (usually) has a fixed rate and you can purchase it from an insured-institution. That means your money is covered if the bank fails.
How CDs Work
When you invest in a CD, you promise to keep your money invested for a certain length of time. In exchange, the bank pays a relatively generous interest rate. Interest rates on CDs are typically the highest rates on any type of bank account including savings accounts, checking accounts, and money market accounts.
You can invest in CDs for terms as few as 3 months and as many as 20 years. Generally, the longer the term, the higher the interest rate paid on your investment.
Interest on a CD might accrue monthly, quarterly, semi-annually, or annually and at maturity. A CD is “mature” when the term ends. For example, if you have a 17-month CD that accrues interest semi-annually, interest would be added at 6 months, 12 months, and 17 months (maturity).
When your CD matures, you have a certain, usually short, period of time, to decide if you want to withdraw the money from your CD or reinvest it for another term. If you do nothing, many banks will automatically renew the CD.
Early Withdrawal Penalty
Choose your CD term carefully and make sure you won’t need access to the money soon. For example, your emergency savings shouldn’t be invested in a CD. If you withdraw your money from the CD before maturity, you’ll have to pay an early withdrawal fee that could forfeit all your interest and even interest you haven’t earned yet. In other words, some of your original deposit could be taken. You can take a tax deduction for an early withdrawal penalty paid on a CD.
Deposit Requirement
Some CDs have a minimum deposit requirement. You would need to invest at least the minimum deposit amount open the CD. Minimum deposits may be as low as $100 or as high as $50,000. Some banks, often online banks, do not have minimum deposit requirements.
Callable Feature
Banks sometimes include a callable feature in CDs, especially long-term, high rate CDs. The callable feature allows the bank to redeem the CD at anytime. The call date is set for a certain period after the CD issued and the bank can decide to call the CD at that time and at recurring periods after that. For example, if your CD is callable at 12 months, the bank can decide to call your CD 12 months after purchase. Then, at another 12 months after that, and so on until the CD matures. Only the bank can call the CD. If you withdraw your money before maturity, you’ll face the early withdrawal penalty mentioned earlier.