Interest on a CD accrues daily. The bank multiplies your current balance by the annual nominal rate and divides by 365 to get one day’s interest, then runs that calculation every day of the term. On a set schedule, the accrued interest gets folded back into your principal through compounding, so each new day’s math runs on a slightly larger number. That is the whole mechanism behind how interest is accrued on a CD, but the timing of when you can actually spend that interest, and when you owe taxes on it, is where things get interesting.
The Daily Accrual Calculation
Interest starts accruing the day you fund the account. Take the principal, multiply by the annual nominal rate, divide by 365. A $10,000 CD at a 5.00% nominal rate earns about $1.37 per day ($10,000 × 0.05 ÷ 365). That figure runs every day of the term, building a growing total of earned interest on the bank’s ledger.
On its own, daily accrual is just arithmetic. The rate locks in when you open the account and cannot change during the term regardless of what happens in the market. That rate lock is the whole point of a CD: you give up access to the money for a guaranteed return. Terms typically run from three months to five years, though some institutions offer them as short as one month or as long as ten years.
Compounding Turns Daily Accrual Into Growth
Accrual is the daily math. Compounding is when the running total of accrued interest gets merged back into the principal so future days’ math runs on a bigger balance. Most CDs compound daily or monthly. With daily compounding, the $1.37 you earn today gets added to your $10,000 tonight, so tomorrow’s calculation runs on $10,001.37. The difference on any single day is fractions of a penny. Over a multi-year term, those fractions stack up.
Compounding is separate from crediting, and confusing the two is common. Compounding happens internally on the bank’s books. Crediting is when the bank actually makes the interest available to you. Some CDs credit interest monthly or quarterly by depositing it into a linked checking or savings account; if you take that option, the CD’s principal stays flat for the whole term because interest leaves as soon as it’s credited. Other CDs credit only at maturity, so you see nothing until the term ends. The arrangement that grows fastest is one where credited interest stays inside the CD, because it compounds along with the original principal.
The disclosure documents at account opening spell out both the compounding frequency and the crediting schedule. They don’t have to match. A CD might compound daily and credit quarterly. If maximizing growth matters, look for daily compounding with interest that stays in the CD.
Nominal Rate vs. APY
Every CD comes with two rate numbers that look similar and mean different things. The nominal rate is the straight annual interest rate the bank quotes. The Annual Percentage Yield (APY) is what you actually earn once compounding does its work over a year. Because you earn interest on previously earned interest, APY is always at least as high as the nominal rate.
Federal regulations require banks and credit unions to disclose APY using a standardized formula so you can compare offers directly.1eCFR. Appendix A to Part 707, Title 12 – Annual Percentage Yield Computation The formula accounts for compounding frequency, which matters more than people expect. A 5.00% nominal rate compounded daily produces a slightly higher APY than the same 5.00% compounded monthly. When comparing CDs, compare APYs, not nominal rates.
When You Owe Taxes on Accrued Interest
CD interest is ordinary income, taxed at your marginal rate.2Internal Revenue Service. Topic No. 403, Interest Received When you owe the tax depends on how the CD is structured, and this is where longer-term CDs surprise people.
For CDs that credit interest at least once a year, the interest is taxable in the year it’s credited. Your bank sends a Form 1099-INT for any year the CD earns $10 or more.3Internal Revenue Service. About Form 1099-INT, Interest Income That reporting threshold comes from federal law requiring information returns on interest payments at or above $10.4Office of the Law Revision Counsel. 26 USC 6049 – Returns Regarding Payments of Interest You report the amount from Box 1 of the 1099-INT on your return.
Now the part that catches people. If you hold a CD with a term longer than one year that doesn’t pay out interest at least annually, the IRS treats the deferred interest as Original Issue Discount (OID). You have to include the OID in income as it accrues each year, even though you haven’t received it.5Internal Revenue Service. Publication 1212, Guide to Original Issue Discount (OID) The bank sends a Form 1099-OID instead of, or in addition to, a 1099-INT for those accounts.6Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID You could owe tax on interest still locked inside a CD you can’t touch without penalty. If a large sum is going into a multi-year CD, plan for that annual tax bill from money outside the CD, or look for a multi-year CD that credits interest at least annually and sidesteps the OID rule.
If you do pay an early withdrawal penalty, the full interest earned still gets reported on your 1099-INT. The penalty is deductible as an adjustment to income on Schedule 1. It’s an above-the-line deduction, so you can claim it whether or not you itemize.
Early Withdrawal Eats Into Accrued Interest
Taking money out before maturity triggers a penalty. Federal rules set only a floor: within the first six days after deposit, the penalty has to be at least seven days’ simple interest.7HelpWithMyBank.gov. What Are the Penalties for Withdrawing Money Early From a Certificate of Deposit Beyond that minimum, there’s no federal cap; banks set their own schedules.8eCFR. 12 CFR Part 1030 – Truth in Savings (Regulation DD)
In practice, penalties commonly run three to six months of interest, with longer terms carrying steeper charges. Some institutions charge a flat fee or a full year of interest on five-year CDs. If the penalty is bigger than the interest accrued so far, the bank takes the difference from your principal. An early withdrawal on a young CD can leave you with less than you deposited. Most CDs also require you to pull the entire balance; partial withdrawals are uncommon.
What Happens at Maturity
When a CD hits its maturity date, you get a short window to decide what happens next. That grace period is typically seven to ten calendar days depending on the institution.9Bankrate. What To Do When a CD Matures During the window you can withdraw the balance, move it elsewhere, or roll it into a new CD at whatever rate the bank currently offers.
Do nothing and the bank automatically renews the CD into a new term of the same length at the prevailing rate. If market rates have dropped, the new rate can be significantly lower than what you originally locked in. Set a calendar reminder a few days before maturity so the decision is deliberate.
Variations That Change the Accrual Picture
Not every CD works the same way. A no-penalty CD lets you withdraw the full balance before maturity without forfeiting interest, but the rate is lower than a traditional CD of the same term. Step-up CDs raise your rate automatically at preset intervals fixed at account opening. Bump-up CDs let you manually request a rate increase (usually one, sometimes two on longer terms) if the bank’s offered rates rise during your term. Step-up and bump-up CDs both start at rates below comparable traditional CDs.
Brokered CDs are bought through a brokerage instead of directly from a bank. The daily accrual math is identical, but exiting early works differently: rather than paying a penalty, you sell the CD on a secondary market. If rates have risen since you bought, your fixed rate looks worse to buyers and you may sell at a loss. If rates have fallen, you could sell at a premium. Holding to maturity avoids the market risk, since you get face value plus accrued interest regardless of what rates have done.