Overview of Certificates of Deposit
Certificates of deposit are temporary deposits. When you purchase a certificate of deposit, you are depositing your money in a financial institution that promises to pay interest in exchange for your commitment to keep the deposit for a specified period of time.
You have the freedom to choose the duration of the certificate of deposit when purchasing it. Typically, the terms of certificates of deposit are expressed in months, generally ranging from a minimum of three months to a maximum of several years. However, your financial institution may offer shorter or longer certificates of deposit.
Interest rates vary based on the duration of the certificate of deposit. You usually receive a higher interest rate for choosing a long-term certificate of deposit.
A certificate of deposit has a maturity date that is part of its name. For example, if you buy a “six-month certificate of deposit,” the certificate will mature six months after you deposit your money into that account. You may see the purchase date of the certificate or the maturity date on your statements (online or paper).
Early Withdrawal
If you withdraw your money from a certificate of deposit before its maturity (also known as “breaking” the certificate), the bank may impose an early withdrawal penalty. This penalty may be presented as a simple interest amount for seven days or you may pay a flat fee.
In some cases, the penalties may wipe out the interest you earn and you may receive 100% (or more) of your invested funds. In other cases, the penalties may impact the original investment, and you may receive less than what you initially deposited.
Liquid Certificates of Deposit
Some certificates of deposit allow withdrawals before maturity without any penalties. These certificates are considered “liquid” and are becoming increasingly popular because people enjoy the flexibility. However, you pay for this in the form of a lower interest rate, so you do not earn much on your money. Some liquid certificates of deposit allow for full withdrawals, while others set limits on withdrawals.
What Happens When a Certificate of Deposit Matures
When your certificate of deposit matures, you have several options, but it’s best to be proactive. If you do not make a choice in a timely manner, a decision may be made automatically on your behalf.
Maturity Notice
Your bank or credit union must send you a notice prior to the maturity of your certificate of deposit. The notice may be sent via regular mail or email, depending on the preferences you have set with your bank. You should pay special attention to the following features:
- The maturity date of your certificate of deposit
- The default action if you do nothing (the maturing certificate may be automatically renewed into a new certificate of deposit, or the cash may be deposited into your account)
- The renewal rate for certificates of deposit (if this is not clear, make sure to find out – the renewal rate may be lower)
- The maturity date of any renewed certificates of deposit, if applicable
- The deadline to change your default action or request a new action
Renewal
If you do nothing and have set up an automatic renewal, your bank typically places your money into another certificate of deposit with the same duration as the previous one that has matured. For example, if your six-month certificate has expired, you may have a ten-day period after maturity to provide instructions to the bank. If you do not provide new instructions, the bank may place the funds into another six-month certificate of deposit. However, you may not receive the same interest rate that you were earning on the previous certificate.
Banks that renew funds from maturing certificates typically pay what they are currently offering to individuals purchasing six-month certificates of deposit, which may be more or less than what you were earning on the previous certificate.
You Have
Options
The most important thing to know is that you have options. When your certificate of deposit (CD) expires, you can (among other things):
- Allow the expired CD to renew into a new certificate of deposit and receive whatever interest rate you get
- Select a different certificate of deposit (perhaps a different term or type of structure)
- Select a different financial institution offering better interest rates on certificates of deposit
- Deposit the money from the expired CD into your checking or savings account and use it for something completely different
One way to treat the funds from an expired CD is as extra money, like if you found an extra $20 bill in your pocket. Assess your financial situation and goals and decide how this extra money can help you achieve those goals.
What is the appropriate maturity?
When purchasing certificates of deposit, you can choose the length of time that the CD will last, and you may not know which maturity to choose. Again, you should determine your goals and cash flow needs to help guide you toward the right maturity. Here are some questions to consider:
Do you want flexibility or yield?
In general, longer terms come with higher interest rates. If you want to maximize profits, a one-year certificate of deposit typically pays more than a three-month certificate of deposit. However, by choosing a one-year CD, you will have less flexibility regarding your money compared to what you would have if you simply enrolled in a three-month CD.
Which direction are interest rates heading?
It may be wise or unwise to lock in money for a longer period, depending on the direction of interest rates. While it’s impossible to know exactly where interest rates are headed, you can gauge the overall interest rate environment to estimate what may happen in the coming months and years.
If you think rates will rise: It may be better to stick with short-term CDs or liquid CDs or high-yield CDs. This way, you’ll have a chance to reset your interest rate earlier, and if rates rise, you’ll get a better rate when resetting after the short-term CD expires. If you think rates will fall: it may be better to lock in the current interest rate. If you buy a two-year certificate of deposit, for example, your interest rate won’t reset for two years. If the interest rate falls during that time, it won’t affect you as much as it would if you had purchased a three-month certificate of deposit instead.
Emphasize flexibility
Fortunately, you don’t have to choose just one maturity. One good strategy may be to spread your money across different maturities. For example:
- Part of it can go into a six-month CD that renews into a new six-month certificate of deposit at maturity.
- Part of it can go into a one-year certificate of deposit.
- The remainder can go into a two-year certificate of deposit.
With this approach, you’ll have a maturity date coming up every six months or so, so you’ll have access to the funds if you need them. This helps you avoid penalties, and you can also manage the risk of not securing the right interest rate.
Frequently Asked Questions (FAQs)
Do I have to pay taxes on CD earnings?
Yes, the money you earn from interest on a certificate of deposit is treated as regular investment income, and you must pay taxes on it at the appropriate tax rate when you withdraw it.
Do…
Can I lose my money in a certificate of deposit?
Generally, certificates of deposit (CDs) are considered very safe investments. If you choose a CD that is insured by the FDIC (which most are), the risk of losing any amount of your principal is very low.
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and maintain the accuracy, reliability, and quality of our content.
Fidelity. “Certificates of Deposit (CDs).”
Board of Governors of the Federal Reserve System. “Small Entity Compliance Guide: Regulation DD: Truth in Savings.”
Securities and Exchange Commission. “High-Yield Certificates of Deposit: Protecting Your Money by Checking the Fine Print.”
Office of the Comptroller. “What Are the Penalties for Withdrawing Funds Early
Source: https://www.thebalancemoney.com/how-cd-maturities-work-315254
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