Contrary to popular belief, not all certificates of deposit (CD) are the same. They come in several variations that make it easy to meet your savings goals with very minimal effort on your part. Keep reading to dive into your options and what each has to offer.
What is a CD?
Before exploring the ins and outs of each type of CD available on the market, it’s worth understanding the basic concept of these savings vehicles and how they work. In a nutshell, a CD is a type of savings account that comes with a fixed interest rate, also known as an annual percentage yield (APY).
CDs pay more in interest than regular savings accounts, but there’s a catch. You must agree to leave your money in the account for a specific term, typically spanning a few months to several years. Should the need arise to withdraw funds, you’ll incur an early withdrawal penalty.
Despite the lack of liquidity, which can be a major drawback for some consumers, CDs are very secure. If held at a bank or credit union insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA), up to $250,000 of your deposit is protected in the event of a bank failure.
Types of CDs
There are traditional, jumbo, no-penalty, high-yield, bump-up, step-up, liquid, callable, brokered and IRA CDs—more on the specifics of each in the coming sections.
Traditional CDs
Traditional CDs are what was described above. Consumers often turn to them to earn predictable turns on their savings without assuming much risk.
Features of Traditional CDs
Again, traditional CDs come with fixed APYs and a set term. Most also require a minimum opening deposit before the account is active and starts earning interest.
Benefits and Drawbacks
Benefits:
- Predictable interest earnings
- FDIC- or NCUA-backing for added protection
Drawbacks:
- Limited liquidity
- Early withdrawal penalties
Jumbo CDs
Definition and Requirements
A jumbo CD is a type of savings account with a large minimum deposit requirement, typically $100,000 or more. That said, you can open them with a much smaller deposit at some financial institutions.
Interest Rates and Returns
Interest rates for jumbo CDs are generally higher than those of standard CDs due to the larger deposit. While the rates are appealing, always consider the flexibility and term length when selecting a jumbo CD.
No-Penalty CDs
No-penalty CDs are a special type of CD that allows you to withdraw your money early without facing any penalties. They provide a balance of security and flexibility, offering higher interest rates than regular savings accounts.
How No-Penalty CDs Work
When you open one, you agree to keep your money in the CD for a set period. The interest rate is fixed, and you earn more over time compared to standard savings accounts. The key feature here is that you can withdraw your funds before the CD reaches its maturity date without paying an early withdrawal fee.
When to Choose No-Penalty CDs
A no-penalty CD could be ideal if you anticipate needing access to your funds prior to the CD maturity date. You’ll likely earn a lower APY with this option, but the liquidity could make the lower earning potential well worth it.
High-Yield CDs
Characteristics of High-Yield CDs
As the name suggests, high-yield CDs generally offer more competitive interest rates than standard CDs. Terms vary, as they do with all CDs, and a minimum deposit is typically required.
Pros and Cons
Pros:
- Greater earning potential compared to traditional CDs
- Federally backed for added protection
Cons:
- Early withdrawal penalties
- Higher minimum opening deposit
Bump-Up CDs
What Are Bump-Up CDs?
Bump-Up CDs let you request a rate increase once during the CD’s term if APYs go up. This practice is not standard with most CDs.
When and Why to Use Bump-Up CDs
You may want to use a Bump-Up CD if interest rates are expected to rise. Doing so lets you boost your earning potential.
Step-Up CDs
Defining Step-Up CDs
A step-up CD is a type of certificate of deposit where banks or credit unions automatically increase your interest rate at specific intervals. The major draw is the ability to earn more without having to constantly monitor market rates.
Incremental Interest Rate Changes
Rate increases provide an added layer of security against interest rate fluctuations in the market. This gradual increase means your money can grow more than with a fixed-rate CD and potentially outpace inflation.
Liquid CDs
Understanding Liquid CDs
Liquid CDs provide fee-free access to your funds before the maturity date. In most instances, you’re required to maintain a minimum balance to steer clear of penalties or account closure.
Flexibility and Accessibility
Liquid CDs are one of the more flexible options, as you can pull cash without having to worry about hefty early withdrawal penalties. For this reason, they often appeal to consumers looking to meet short-term savings goals or build an emergency fund.
This level of increased accessibility comes with trade-offs, though. Liquid CDs often offer lower rates than traditional CDs, which means you’ll earn less.
Callable CDs
What Are Callable CDs?
A callable CD is a type of certificate of deposit where the bank reserves the right to terminate or “call” the CD before its maturity date. This usually happens when interest rates in the market drop, allowing the bank to refinance at a lower rate.
These CDs often offer a higher initial interest rate compared to non-callable CDs as compensation for this early termination risk. The callable period, during which the bank can choose to call the CD, is typically defined in the terms agreement. If the bank decides not to call the CD, you benefit from the interest rate for the entire term.
Risks and Rewards
Risks:
- Potential for early termination by the bank
- Forfeiture of earnings if CD carries a lower rate for a bit before it’s called
Rewards:
- More attractive APYs than traditional CDs
Brokered CDs
Brokered CDs are certificates of deposit purchased through a brokerage firm instead of directly from a bank.
How Brokered CDs Differ
Brokered CDs are far more flexible than traditional CDs offered directly by banks and credit unions. You get the luxury of choosing from CDs issued by several banks, each offering a variety of interest rates and terms.
Keep in mind that selling these CDs before maturity to access cash or invest them elsewhere might be challenging. The secondary market can affect the value of your CD since prices fluctuate with interest rate changes. This can create hurdles that you’ll have to overcome to get rid of this type of CD.
Advantages and Disadvantages
Advantages:
- Access to a broader range of banks and terms
- Potential for higher yields
- Convenient way to diversify your portfolio
Disadvantages:
- Broker fees can lower overall returns
IRA CDs
What Are IRA CDs?
IRA CDs combine the benefits of a Certificate of Deposit and Individual Retirement Accounts. They offer a safe, low-risk way to save for retirement and offer specific tax benefits.
Tax Advantages and Restrictions
With a traditional IRA CD, your contributions may be tax deductible, depending on your income and filing status. This means you can potentially lower your taxable income now and pay taxes later when you begin taking distributions.
For Roth IRA CDs, contributions are made with after-tax dollars so that you can make tax-free withdrawals during retirement.
Factors to Consider When Choosing a CD
Here’s what to consider when scoping out your options to find the best CD for your financial situation.
Interest Rates
Higher interest rates generally mean a better return on your investment. So, it’s best to shop around and compare rates from different banks and credit unions. Keep an eye on trends in national averages, as they can influence the rates offered by various institutions.
Remember, some promotional rates banks and credit unions offer may have specific terms or requirements, so always read the fine print.
Term Length
Shorter terms often offer lower rates but provide flexibility if you need access to your funds sooner. Longer terms tend to have higher rates but require you to commit your money for a more extended period.
Evaluate your financial needs to decide how long you’re comfortable keeping your money tied up.
Penalties for Early Withdrawal
The amount you’ll pay can vary widely among institutions and might cost you a portion of the interest earned or even some of the principal amount. If you think you might need access to your funds before the term ends, look for CDs with more lenient withdrawal terms or consider other savings options.
Financial Goals
If you’re saving for a short-term goal, a CD with a shorter term might suit your needs best. For long-term savings, higher interest rates on longer-term CDs can be ideal.
Conclusion: Choosing Which CD Type is Right for You
With so many variations of CDs to choose from, it can quickly become overwhelming to identify the best option for you. But with the help of this guide, you should be equipped with the knowledge needed to make an informed decision.
