Certificates of Deposit

by Paul R. Ruedi, CFP®

A Certificate of Deposit or “CD” for short is an agreement to keep a deposit at a savings institution for a specified term that can be as short as a few months or as long as a decade. In exchange for doing so, savers receive interest on their deposits that build up until their maturity date when the funds can be withdrawn or rolled into a new CD. Though CDs can be withdrawn before they mature, there is a penalty for doing so. This is a key distinction between a CD and a savings account, since money in savings accounts can be withdrawn at any time.

Most CDs pay a fixed interest rate that is locked for the entire term and will not be impacted by movements in the prevailing interest rates. Other CDs may offer a rate that can rise or fall with interest rate movements, or may be fixed for a time with the option to bump up the rate later. Though interest is often paid monthly or quarterly, you cannot withdraw the interest payments without penalty until the CD matures. But savers should be aware that any interest the CD paid is considered taxable interest income even though you cannot withdraw those interest payments without penalty.

The rate investors receive on CDs is very low because they are considered extremely safe. Certificates of Deposit are insured up to $250,000 by the FDIC for banks, and NCUA for credit unions, so savers are covered even if the financial institution that issued their CD goes under. Because they have to compensate savers for locking their money up for a certain period of time, they pay an interest rate above that of a typical savings account.

A CD can be a good option for someone who wants to set aside funds they will not need for a certain period of time in a very safe way. But because they are so safe the interest rates they offer usually do not keep up with inflation. For this reason they are not a great option for those looking to grow their wealth and fund long-term goals.

There are many brick and mortar and online options for those looking to purchase CDs. The terms, interest rates, and early withdrawal penalties are all set by the financial institutions that offer CDs so it is very important to shop around. If you are unsure how to decide between different CDs, or are wondering if CDs fit in to your financial plans, you may want to talk to a financial advisor.

Paul R. Ruedi is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.