A certificate of deposit, or CD, is a bank or credit union account that holds a lump sum of your money for a set period and pays a guaranteed interest rate in return. Understanding how a CD works in banking comes down to three things: you agree to leave the money alone for a fixed term, the bank agrees to pay a rate it can’t change, and if you break the agreement early you pay a penalty. Your deposit is federally insured up to $250,000, which makes CDs one of the safest places to hold cash you won’t need for a while.
The Basic Mechanics
When you open a CD, you pick a term, hand over a lump sum, and the bank locks in an interest rate for the entire period. Neither side can change that rate once the contract starts. At the end of the term (called maturity), you get your original deposit back plus all the interest it earned.
The trade-off is liquidity. Unlike a checking or savings account, you can’t dip into a CD whenever you want without a penalty. The bank pays a better rate precisely because it can count on your money staying put for a known stretch of time.
CDs at FDIC-insured banks are protected up to $250,000 per depositor, per institution, for each ownership category.1Federal Deposit Insurance Corporation. Understanding Deposit Insurance Credit union CDs get the same $250,000 coverage through the National Credit Union Share Insurance Fund.2National Credit Union Administration. Share Insurance Coverage One detail that trips people up: accrued interest counts toward the $250,000 cap, not just your original deposit.3Federal Deposit Insurance Corporation. Shopping for a Certificate of Deposit? If you already hold significant balances at the same bank, a new CD could push you above the insured limit.
How the Interest Is Paid
Terms typically run from three months to five years. Shorter terms usually pay less but free up your money sooner. Longer terms often pay more because you’re committing your cash longer. As of March 2026, national averages sit around 1.52% for a 12-month CD, 1.31% for 36 months, and 1.34% for 60 months.4Federal Deposit Insurance Corporation. National Rates and Rate Caps Those are just averages. Online banks and credit unions frequently pay well above them, so shopping around matters.
When comparing offers, look at the annual percentage yield rather than the stated interest rate. The APY reflects how compounding boosts your return. Banks may compound interest daily, monthly, or quarterly, and more frequent compounding means your earned interest starts earning interest of its own sooner. Two CDs with the same stated rate but different compounding frequencies produce different total returns. The APY captures that difference in one number.
Over a three-month CD, the gap between the rate and the APY is trivial. Over five years, it’s real money.
What You Need to Open One
To open a CD, you’ll choose a term, deposit amount, and often a beneficiary. Federal rules require the bank to verify your name, date of birth, address, and an identification number such as a Social Security number or ITIN.5HelpWithMyBank.gov. Required Identification Bring a photo ID like a driver’s license or passport.6Consumer Financial Protection Bureau. Checklist for Opening a Bank or Credit Union Account
Minimum deposits vary a lot. Some online banks have no minimum. Others require $500, $2,500, or more. Jumbo CDs, aimed at larger balances, typically require at least $100,000 and may pay a slightly higher rate in exchange.
With a standard CD, you can’t add more money after the initial deposit. Once the funds are in, they’re in until maturity. If you want to keep contributing, ask specifically about an add-on CD, which allows more deposits during the term at the original locked-in rate.
Taxes on CD Interest
Interest earned on a CD is taxable as ordinary income. You owe tax on it in the year it gets credited to your account, even if you never withdraw it and let it keep compounding inside the CD.7Internal Revenue Service. Topic No. 403, Interest Received That surprises people with multi-year CDs: each year, you owe income tax on interest you can’t actually touch without paying an early withdrawal penalty.
Banks send you Form 1099-INT if they paid you $10 or more in interest during the year.8Internal Revenue Service. About Form 1099-INT, Interest Income Even without the form, you still have to report the full amount on your federal return.7Internal Revenue Service. Topic No. 403, Interest Received
Early Withdrawal Penalties
Pulling money out before maturity triggers a penalty. Federal regulation sets a floor: a time deposit must carry at least a seven-day interest penalty on early withdrawals.9eCFR. 12 CFR Part 1030 – Truth in Savings (Regulation DD) In practice, banks charge much more than the minimum. A typical penalty on a one-year CD is three months of interest. On a five-year CD, it might be six months or a full year of interest.
The penalty normally comes out of the interest you’ve earned. But if you withdraw so early that you haven’t earned enough to cover it, the bank takes the difference from your principal. You’d walk away with less than you deposited. That’s the main reason to match the CD term to when you’ll actually need the money.
Federal rules identify two situations where the bank can waive the penalty entirely: the death of an account owner, or a court determination that an owner is legally incompetent.10eCFR. 12 CFR Part 204 – Reserve Requirements of Depository Institutions Beyond those, waiver is entirely up to the bank. Asking during a genuine hardship sometimes works, but there’s no legal right to one.
What Happens When the Term Ends
When your CD reaches maturity, most banks give you a short grace period to decide what to do with the money. Regulation requires banks to disclose whether a grace period exists and how long it runs, without mandating a specific length beyond a five-day minimum tied to certain disclosure timing.9eCFR. 12 CFR Part 1030 – Truth in Savings (Regulation DD) In practice, grace periods typically run about 10 calendar days.11Citizens Bank. Frequently Asked Questions: CDs
During that window you can withdraw everything penalty-free, move the money elsewhere, or renew into a new CD. If you do nothing, the bank automatically rolls your balance into a new CD of the same term at whatever rate it’s currently paying. That rollover rate is almost never the best available, and this is where most CD holders lose ground. Banks count on inertia.
Banks with auto-renewing CDs must send you a maturity notice in advance. For terms longer than one month, the notice goes out at least 30 days before maturity, or at least 20 days before the grace period ends.9eCFR. 12 CFR Part 1030 – Truth in Savings (Regulation DD) Put a reminder on your own calendar too. Once the grace period closes, you’re locked in again.
Common Variations on the Standard CD
Not every CD works exactly like the description above. Several specialty types change one piece of the standard deal.
No-Penalty CDs
A no-penalty CD lets you withdraw the full balance and earned interest without forfeiture, usually after the first six or seven days. In exchange, the rate is lower than a standard CD of the same term. These sit between a high-yield savings account and a traditional CD.
Bump-Up CDs
A bump-up CD gives you the option to request a higher rate if the bank raises its rates during your term. Most limit you to a single increase, though some longer terms allow two. The starting rate is usually lower than a fixed-rate CD, which is the price of the option.
Add-On CDs
An add-on CD lets you deposit additional money during the term at the original locked-in rate. Useful if you’re saving toward a goal and don’t want to open a new CD every time you have cash to add.
Callable CDs
A callable CD pays a higher rate, but the bank can end it early after a call protection window, typically six months to five years. If rates drop, the bank has an incentive to call the CD and stop paying you the higher rate. You get your principal and interest earned to that point, but you lose the rate and have to reinvest at whatever’s available.
Brokered CDs
Brokered CDs are bought through a brokerage firm rather than directly from a bank. FDIC insurance still applies up to $250,000 at the issuing bank, but certain conditions must be met for coverage to pass through from the broker.12Federal Deposit Insurance Corporation. Pass-Through Deposit Insurance Coverage Exiting early works differently: instead of a bank penalty, you sell the CD on a secondary market. If rates have risen, buyers will pay less for your lower-yielding certificate, and you could lose principal. If rates have fallen, you may be able to sell at a profit.13Charles Schwab. Bank CDs vs. Brokered CDs: What’s the Difference? There’s also no guarantee a buyer will be there when you want to sell.
IRA CDs
You can hold a CD inside a traditional or Roth IRA. Interest grows tax-deferred (traditional) or tax-free on qualified withdrawals (Roth), which avoids the annual tax headache. The catch: pulling money out of the IRA before age 59½ generally adds a 10% additional tax on top of whatever penalty the bank charges for breaking the CD early.14Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions For 2026, the IRA contribution limit is $7,500 if you’re under 50, or $8,600 if you’re 50 or older.15Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
CD Laddering
Because a CD locks up your money, many depositors spread deposits across several CDs with staggered maturity dates instead of putting everything in one. This is called laddering. You might put equal amounts into one-year, two-year, and three-year CDs. When the one-year matures, you reinvest it into a new three-year CD. A year later, the original two-year matures and you do the same. Eventually every rung is a three-year CD, but one matures every year.
The result is that you capture the higher rates that come with longer terms while still freeing up a portion of your cash annually. Laddering also hedges against rate movement. If rates rise, you have money coming available to reinvest at the new higher rate. If rates fall, you’ve already locked in longer-term rates on the rest of the ladder.