Certificate of Deposit (CD)

What Is a Certificate of Deposit (CD)?

A Certificate of Deposit (CD) is a savings product offered by banks and credit unions that provides a fixed interest rate in return for the customer’s agreement to leave a lump-sum deposit untouched for a specific period. CDs are a low-risk investment suitable for individuals seeking predictable returns and higher interest rates compared to regular savings accounts. The term length can vary from a few months to several years, and penalties typically apply for early withdrawals.

Examples of Certificates of Deposit

Short-Term CD: A CD with a term length of 3 to 6 months, often chosen by investors who anticipate needing liquidity in a shorter timeframe.
Long-Term CD: A CD with a term length of 5 years or more, offering higher interest rates because of the longer commitment period by the investor.
Jumbo CD: A CD that usually requires a minimum deposit of $100,000, often offering higher interest rates due to the large denomination.
Risk-free CD: A savings product that offers the flexibility to withdraw principal funds without incurring penalties, though generally providing lower interest rates compared to traditional CDs.

Frequently Asked Questions (FAQs)

Q: What happens if I withdraw my funds from a CD early? A: Most CDs impose a penalty for early withdrawal, which can vary but often includes losing interest earned or paying a set fee. The specifics depend on the terms outlined by the issuing bank or credit union.

Q: Are there different types of CDs available? A: Yes, there are various types of CDs including traditional CDs, bump-up CDs, liquid CDs, and callable CDs, each offering different terms and features.

Q: How is the interest earned on a CD taxed? A: Interest earned on a CD is considered taxable income and should be reported on your annual tax return. The bank or credit union will issue a 1099-INT form for interest earned over $10.

Q: What determines the interest rate of a CD? A: The interest rate on a CD is influenced by factors such as the term length, the amount deposited, prevailing interest rates, and the financial institution’s policies.

Q: Can I add more money to my CD after the initial deposit? A: Typically, once a CD is opened and funded, additional deposits are not allowed until maturity. However, some banks offer add-on CDs allowing additional contributions.

Savings Account: A deposit account held at a bank or other financial institution that provides principal security and modest interest rates.
Money Market Account: A type of savings account that often requires a higher minimum balance and offers a higher interest rate compared to a regular savings account.
Fixed-Rate Investment: An investment that yields a fixed rate of return over its term, providing predictable income.
Annual Percentage Yield (APY): The real rate of return earned on an investment or savings account, considered over a compounding period, typically one year.

Online Resources

References

“Understanding Certificates of Deposit - FDIC.” FDIC Consumer News. Available here
“Certificate of Deposit (CD)” Investopedia. Available here
“Savings Bonds vs. CDs” U.S. Securities and Exchange Commission. Available here

Suggested Books for Further Studies

“CD and Money Market Investing for Beginners” by Richard A. Ferri
“Investing in Fixed Income Securities” by Gary Strumeyer
“The Bank Investor’s Handbook” by Nathan Tobik and Kenneth Yellen
“Personal Finance After 50 for Dummies” by Eric Tyson and Robert C. Carlson

Real Estate Basics: Certificate of Deposit (CD) Fundamentals Quiz

### Can a customer withdraw funds from a CD at any time without penalty? - [ ] Yes, there are no penalties for early withdrawals. - [x] No, most CDs have early withdrawal penalties. - [ ] Early withdrawals are subject to a small fee only. - [ ] CD funds can be accessed freely like a savings account. > **Explanation:** Most CDs come with early withdrawal penalties, often equivalent to several months of interest, which serves as a deterrent against withdrawing the deposited funds before the maturity date. ### What is typically required to open a jumbo CD? - [ ] A minimum deposit of $1,000 - [ ] At least a term length of one year - [x] A minimum deposit of $100,000 - [ ] Monthly fee payments > **Explanation:** Jumbo CDs require significantly larger deposits, often starting at $100,000, and typically offer higher interest rates due to the larger amount invested. ### How does the interest rate of a CD generally compare to a regular savings account? - [ ] CD rates are usually lower. - [x] CDs typically offer higher interest rates. - [ ] They have the same interest rates. - [ ] CD interest rates fluctuate daily. > **Explanation:** CDs generally offer higher interest rates compared to regular savings accounts because the funds are locked in for a set term, providing greater predictability for the financial institution. ### What is the primary benefit of a fixed-rate CD? - [x] It provides a guaranteed return. - [ ] It offers the highest possible interest rate option available. - [ ] It allows for unlimited additional contributions. - [ ] It can be easily converted to a checking account. > **Explanation:** A fixed-rate CD guarantees a predetermined interest rate for the entire term of the deposit, offering predictable returns regardless of market interest rate fluctuations. ### What major factor determines the amount of interest earned on a CD? - [x] The term length and initial deposit amount - [ ] The current year’s macroeconomic trends - [ ] The customer's credit history - [ ] The bank’s reserve ratio > **Explanation:** The amount of interest earned on a CD primarily depends on the term length and the amount of the initial deposit. Longer terms and higher deposit amounts typically yield better interest rates. ### What defines a “bump-up” CD? - [ ] A CD that allows monthly additional contributions - [x] A CD that permits one-time rate changes during the term - [ ] A penalty-free withdrawal CD - [ ] A special rate CD for senior citizens > **Explanation:** A bump-up CD allows the holder to request a one-time increase in the interest rate if rates rise during the term, providing some flexibility to take advantage of rising rates. ### What does the term “maturity” refer to in the context of a CD? - [x] The end date of the CD term - [ ] The minimum deposit required to open a CD - [ ] The initial deposit amount - [ ] The age of the account holder > **Explanation:** Maturity refers to the end date of the CD term when the principal and the interest earned become due to the account holder. ### Who are CDs most suitable for? - [ ] Individuals requiring constant access to funds - [x] Investors looking for low-risk, fixed returns - [ ] Those seeking high returns with high-risk options - [ ] Day traders > **Explanation:** CDs are especially suitable for conservative investors looking for low-risk, fixed returns over a predetermined period, providing a secure form of saving with predictable earnings. ### What happens if interest rates rise significantly during a fixed-rate CD term? - [x] The interest rate on the CD remains the same. - [ ] The CD rate automatically adjusts upwards. - [ ] The investor must close the CD early. - [ ] The bank can reduce the promised interest rate. > **Explanation:** For a fixed-rate CD, the interest rate remains locked in for the entire term, unaffected by changes in prevailing market interest rates. ### How is a “liquid CD” different from a traditional CD? - [ ] It provides a higher interest rate. - [x] It allows penalty-free withdrawals under specific conditions. - [ ] It requires a higher minimum deposit. - [ ] It has a variable interest rate. > **Explanation:** A liquid CD allows for limited, penalty-free withdrawals or access to a portion of the funds before maturity, offering more liquidity compared to traditional CDs which have strict penalties for early withdrawals.

Certificate of Deposit (CD)