What are Certificates of Deposit (CDs)? | Vanguard (2024)

FAQs

What is a certificate of deposit CD and how does it work? ›

A certificate of deposit (CD) is a savings account that holds a fixed amount of money for a fixed period of time, such as six months, one year, or five years, and in exchange, the issuing bank pays interest. When you cash in or redeem your CD, you receive the money you originally invested plus any interest.

The biggest risk to CD accounts is usually an interest-rate risk, as federal rate cuts could lead banks to pay out less to savers.

This CD will earn $117.15 on $500 over five years, which means your deposit will grow by 23.4%.

The cons of CDs

With a savings account, the money is easily accessible in case of a financial emergency or a change in spending priorities. With CDs, you typically can't withdraw the money whenever you want—at least not without paying a penalty.

CD investing offers a return without any loss, since CDs are a type of savings deposit account. These accounts are insured at banks that are members of the Federal Deposit Insurance Corp. (FDIC), so even if a bank goes under, you're guaranteed your money, up to a certain amount.

One of the bigger disadvantages of certificates of deposits is they're subject to taxes. Any interest earned must be claimed in the year it was earned and not just the year when your CD terms. Depending on your income and deductions, this could lower your tax refund received.

CDs are among the safest investments you can make with your savings. These accounts are insured by FDIC (if a bank) or NCUA (if a credit union) up to $250,000. As a deposit account, a CD is more like a very safe savings account, not an account with stocks or bonds you could lose money on.

The deposit amount won't be prohibitive

But you'll still earn hundreds and possibly thousands of dollars worth of interest with that manageable deposit. For example, a $5,000 deposit into a 5-year CD with a rate of 4.35% (available right now) will result in a $1,186.32 profit upon maturity.

The taxes on CDs are similar to those on other types of interest income, such as interest earned on bonds. Both are considered taxable income and subject to federal income tax, which is based on your marginal tax bracket. However, there are some investments, such as stocks and mutual funds, which are taxed differently.

How much does a $20,000 CD make in a year? ›

That said, here's how much you could expect to make by depositing $20,000 into a one-year CD now, broken down by four readily available interest rates (interest compounding annually): At 6.00%: $1,200 (for a total of $21,200 after one year) At 5.75%: $1,150 (for a total of $21,150 after one year)

As reported by the FDIC, the average annual percentage yield (APY) for a one-year certificate of deposit (CD) is 1.85%. If you invest $50,000 in a one-year CD with this APY, you will earn $925 in interest by the end of the term. However, you can find financial institutions offering CDs with as much as 6.00% APY.

That's up to each issuer. In practice, however, most CDs compound either daily or monthly. The more frequent the compounding, the more interest your interest will earn. The frequency with which your CD compounds is reflected in the annual percentage yield (APY) that the CD's issuer promises you when you buy a CD.

In summary, a certificate of deposit gives you steady and safe returns. Investing $15,000 in a CD could lead to substantial gains, regardless of the CD's length. However, make sure you won't need that money while the CD is active because withdrawing early usually incurs hefty penalties.

Today's CD rates are still high

One of the most compelling reasons to put $10,000 into a long-term CD investment now is the current state of interest rates. CD rates remain at levels we haven't seen in years, and many financial institutions are offering rates of 4% to 5% or more on their long-term CDs.

CDs differ from other savings accounts because you have to keep money locked in for a period of time. You'll only be able to make a deposit when you first open a CD. You also won't be able to make any penalty-free withdrawals until your term ends.

A CD's maturity occurs on the agreed-upon date on which your account's fixed term ends. Until this date, your CD earns interest, but you usually can't withdraw funds from the account without being penalized. Typically, CD terms range from three months to five years (although some banks offer shorter or longer terms).