Certificates of deposit are low-risk investments that can help you earn moderate returns on your money. You deposit a specified amount for a fixed period and then collect your earnings when the certificate matures.
FDIC Coverage of Certificates
The Federal Deposit Insurance Corporation (FDIC) was established by Congress to provide insurance on deposits held in U.S. banks. Simply put, if you deposit money in an insured U.S. bank and it fails, FDIC insurance will cover up to $250,000 of your money in that bank. This amount covers deposits made in certificates of deposit, as well as deposits in checking and savings accounts.
How Do Brokered CDs Differ?
When purchasing brokered certificates of deposit through a third party, you cannot be assured that your deposit is insured by the FDIC.
In order for a brokered certificate of deposit to be FDIC insured, the broker must place your money in a certificate of deposit at an FDIC-insured bank. Before investing, you can ask your broker for the name of the bank issuing the certificate and verify that it is FDIC insured using the online FDIC database.
Additionally, your deposit account records should show that the broker is the “custodian for customers” so that the insurance covers the broker and is directed to you. This is known as “pass-through” FDIC insurance.
Early Withdrawal Penalties
Traditional certificates of deposit require you to leave your deposit in the account for a specified period of time, known as the term. In return, you earn interest, which you will receive when your certificate matures.
If you withdraw your money before your certificate matures, you will likely have to pay an early withdrawal penalty. The penalty depends on the issuer of your certificate and may be structured as follows:
- A period of interest earned
- A percentage of your withdrawal amount
- A percentage of the interest you’ve earned
- A flat fee
The longer the term of the certificate, the higher the penalty typically is. Some institutions also impose higher penalties if you withdraw your money earlier in the term. For example, in PenFed Bank’s certificates of deposit for more than 12 months, you will owe any interest earned if you withdraw your money in the first year. After that, you will have to pay 30% of the total earnings you would have made if the certificate had reached maturity.
You can avoid early withdrawal fees by keeping your money in certificates of deposit until they mature. If you have any doubts about the possibility of needing to end your certificate’s term early, choose a shorter term. You can also structure your investments using a laddering strategy. For example, instead of investing $10,000 in a five-year certificate of deposit, you could invest $2,000 in five separate certificates with one-year, two-year, three-year, four-year, and five-year terms. As each certificate matures, you can reinvest the money into a five-year certificate, and eventually, you will have a five-year certificate maturing each year.
How Do Callable CDs Work?
Callable certificates of deposit are CDs that the issuing bank can terminate after a specified period (known as the call period). If your CD is called, you will get your deposit back, along with any accrued interest, instead of completing the term.
Banks typically call callable CDs if interest rates drop significantly below the agreed-upon rate in the CD. Unfortunately, as the account holder, you usually do not have the same option to call the certificate.
Callable CDs may offer attractive interest rates. However, they may be less predictable than non-callable CDs because there is no guarantee that you will earn that interest for the entire term.
Requirements
Opening a Certificate of Deposit
If you wish to open a Certificate of Deposit, you will typically need to provide basic information such as your name, address, email, phone number, date of birth, and your Social Security number.
You may also need to provide information regarding your country of citizenship, employment, and the source of your deposits. Then, you will need to review and agree to various disclosures, such as the deposit account agreement, privacy statement, interest rate disclosure, and annual percentage rate information. Finally, you will need to submit or verify your W-9 form before your initial deposit.
Frequently Asked Questions
Why is a Certificate of Deposit considered a safe investment?
Traditional Certificates of Deposit are considered safe investments because they offer a guaranteed rate of return for a specified period while being insured by the government up to $250,000.
What is the minimum balance for a Certificate of Deposit?
There is no federal law requiring a minimum balance to open a Certificate of Deposit. The amount required will vary from one institution to another. Some institutions, such as Capital One, do not have a minimum requirement to open a Certificate of Deposit account, while others may require amounts ranging from $500 to $25,000. Large certificates may require deposits of $100,000 or more.
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Sources:
- FDIC. “What’s Covered: Are my Deposit Accounts Insured by the FDIC?”
- FDIC. “Thinking of Buying a CD? What to Consider Before Handing Over Your Money.”
- NCUA. “How Your Accounts Are Federally Insured.”
- FDIC. “When a Broker Offers a Bank CD: It Pays to Do Some Research.”
- PenFed Credit Union. “Money Market Certificates,” see “FAQ.”
- HelpWithMyBank.gov. “What Are the Penalties for Withdrawing Money Early From a Certificate of Deposit (CD)?”
- Securities and Exchange Commission. “High-Yield CDs: Protect Your Money by Checking the Fine Print,” See “Investigate Any Call Features.”
- FRED, Federal Reserve Bank of St. Louis. “National Rate on Jumbo Deposits (Greater or Equal to $100,000).”
Source: https://www.thebalancemoney.com/certificate-of-deposit-rules-and-regulations-5224072
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