A certificate of deposit, or CD, works by locking a lump-sum deposit at a fixed interest rate for a set term, paying you a guaranteed return when that term ends. In exchange for agreeing not to touch the money, you earn more than a typical savings account pays. Pull the money out before the term is up and the bank charges a penalty. CDs at banks are federally insured up to $250,000 per depositor, per institution, per ownership category, which puts them among the lowest-risk places to hold cash you won’t need for a while.
The Basic Mechanics
You deposit a lump sum, agree to leave it for a term that can run anywhere from one month to five years or more, and the bank pays you a fixed interest rate for the entire term. The bank uses your deposit to fund its lending, and your locked-in rate is the price it pays to borrow from you.
Two numbers appear on every CD offer: the interest rate and the annual percentage yield (APY). The APY includes the effect of compounding. If your CD compounds daily, each day’s interest gets added to the balance and starts earning its own interest the next day. Monthly or quarterly compounding works the same way at longer intervals, with slightly less growth. Banks must disclose the interest rate, the APY, and the compounding frequency before you open the account, so you can compare offers on the same footing.1eCFR. 12 CFR Part 1030 – Truth in Savings (Regulation DD)
Because the rate is fixed, you know on day one what the CD will be worth at maturity, assuming you leave it alone. That predictability is the whole point.
The federal insurance backing sits underneath all of this. The FDIC covers CDs at banks; the National Credit Union Administration covers share certificates at credit unions. Both programs cover up to $250,000 per depositor, per institution, for each ownership category.2eCFR. 12 CFR 330.1 – Definitions3eCFR. 12 CFR Part 745 – Share Insurance and Appendix Joint accounts get separate coverage: each co-owner is insured up to $250,000 for the combined total of joint accounts at the same bank, so a CD owned jointly by two people can carry up to $500,000 in protection.4FDIC. Joint Accounts Two individually owned CDs at the same bank share one $250,000 cap, so if you’re moving large sums, the ownership categories are what let you insure well beyond that limit at a single institution.
What Determines the Rate You Get
CD rates track the federal funds rate set by the Federal Reserve. When the Fed raises rates, banks can charge more for loans and pass some of that margin along as higher CD yields. When the Fed cuts, CD yields follow downward. As of late 2025, the federal funds target range was 3.75% to 4.00%, with further cuts projected into 2026, and CD rates had been gradually declining from their recent highs.
Longer terms don’t always pay more. In a normal environment, a five-year CD offers a higher APY than a one-year CD because you’re tying up your money longer. When the market expects rates to fall, short-term CDs sometimes match or exceed long-term ones, because banks don’t want to commit to paying high rates for years.
Where you shop matters more than most people realize. Online banks routinely offer APYs roughly double the national average because they run leaner and compete harder for deposits. In early 2026, the national average one-year CD rate hovered near 1.9%, while the best online offers for the same term exceeded 4%.
Common Types of CDs
The standard fixed-rate CD is what most people mean by “a CD.” Several variations exist for savers with different priorities.
- Bump-up CD. You can request a rate increase once or twice during the term if the bank raises its rates on new CDs. The starting rate is usually a bit lower than a comparable traditional CD to account for the flexibility.
- Step-up CD. Similar idea, but the rate rises on a predetermined schedule instead of at your request. A three-year step-up CD might raise the rate by a set amount every six months automatically.
- No-penalty CD. You can withdraw the full balance before maturity without a penalty. The tradeoff is a lower rate, generally 0.2 to 0.5 percentage points less than a traditional CD for the same term.
- Add-on CD. Unlike a traditional CD, you can deposit additional money after opening. The new money earns the same fixed rate for the remaining term.
- Jumbo CD. Requires a minimum deposit of $100,000, sometimes in exchange for a slightly higher rate.
- Callable CD. The bank reserves the right to terminate the CD early and return your principal. Only the bank can call it, not you. Banks typically do this when rates fall and they no longer want to pay the higher locked-in rate. You get your money back, but you lose the yield and have to reinvest at lower rates.
One product worth naming as a boundary: a brokered CD is bought through a brokerage rather than directly from a bank, and getting out early means selling on a secondary market at whatever price current rates dictate, not paying a fixed penalty.5Investor.gov. Brokered CDs: Investor Bulletin The mechanics below cover bank CDs, not brokered ones.
Opening and Funding a CD
Federal law requires the bank to verify your identity. You’ll provide your name, address, date of birth, and a taxpayer identification number (a Social Security number for most people), along with a government-issued photo ID such as a driver’s license or passport.6eCFR. 31 CFR 1020.220 – Customer Identification Program Requirements for Banks
Minimum deposits vary. At major banks, standard CDs typically start at $500 to $1,000. Some online banks have no minimum at all. You’ll pick a term and decide how you want the interest handled. Most savers reinvest interest back into the CD so it compounds over the full term, but you can usually route interest payments to a linked checking or savings account if you want periodic income.
CDs can also be held inside a traditional or Roth IRA, combining the guaranteed return with the tax treatment of the retirement account.7Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
Getting Your Money Out Early
Pulling money out before maturity costs you. Federal regulations set a floor: any withdrawal within the first six days after deposit must trigger a penalty of at least seven days’ simple interest.8eCFR. 12 CFR 204.2 – Definitions Banks almost always charge more than the floor. A common structure is 90 days of interest on terms of one year or less and 180 days on longer terms, with some banks charging more on CDs of three years or more.
The penalty comes out of your interest first. If it exceeds the interest earned so far, the bank takes the rest from your principal, and you get back less than you deposited. Withdrawing from a five-year CD after only a few months can easily eat into the original deposit.
When Penalties Are Waived
Federal regulations carve out a few situations where the bank can release CD funds without an early withdrawal penalty:
- Death of an account owner. The estate or beneficiaries can access the funds penalty-free.
- Legal incompetency. If a court determines an account owner is legally incompetent, the funds can be released without penalty.
- IRA or retirement plan CDs. Distributions from an IRA, Keogh plan, or 401(k) CD can be made without the time-deposit penalty once the account holder reaches age 59½ or becomes disabled.
These exceptions apply to the bank’s obligation under Regulation D. They do not waive separate IRS penalties for early retirement distributions, which are a different matter.9eCFR. 12 CFR Part 204 – Reserve Requirements of Depository Institutions (Regulation D)
How the Penalty Is Taxed
CD interest is taxable income. The IRS treats it the same as interest from any other bank account: you owe federal income tax on it in the year it becomes available to you, even if you don’t withdraw it. If your CD earns $10 or more in interest during the year, the bank sends you a Form 1099-INT. You must report all taxable interest on your return whether or not you receive the form.10Internal Revenue Service. Topic No. 403, Interest Received
If you do pay an early withdrawal penalty, it’s deductible. The penalty appears in Box 2 of the 1099-INT, and you claim it on Schedule 1 (Form 1040), line 18. It’s an above-the-line deduction, so you don’t need to itemize. You report the full interest earned and then subtract the penalty separately.11Internal Revenue Service. Publication 550, Investment Income and Expenses
What Happens at Maturity
When your term ends, the bank must notify you at least 30 calendar days before the maturity date. Alternatively, it can send notice at least 20 days before the end of a grace period, as long as the grace period is at least five calendar days.12Consumer Financial Protection Bureau. 12 CFR Part 1030 (Regulation DD) – 1030.5 Subsequent Disclosures The notice lays out your options: withdraw the funds, change the term, or let the bank renew the CD automatically.
The grace period is your window to act without penalty. During those days after maturity, you can pull the money out, move it to a different account, or shop for a better rate elsewhere. The exact length varies by bank, but the federal minimum is five days.12Consumer Financial Protection Bureau. 12 CFR Part 1030 (Regulation DD) – 1030.5 Subsequent Disclosures
Miss the grace period and do nothing, and most banks automatically roll your balance into a new CD with a similar term at whatever rate they’re currently offering. That new rate could be well below what you were earning, and you’re locked in for another full term with early withdrawal penalties reattached. Set a calendar reminder at least 30 days before maturity so you have time to compare.
Reducing the Lock-Up Problem With a CD Ladder
The biggest practical drawback of a CD is illiquidity. A CD ladder addresses that. Instead of putting everything into a single long-term CD, you split the money across CDs with staggered maturity dates. As each one matures, you either use the cash or reinvest it into a new long-term CD.
Say you have $5,000. You open five CDs of $1,000 each with terms of one, two, three, four, and five years. After year one, the shortest matures and you reinvest it (plus interest) into a new five-year CD. After year two, the original two-year matures and you do the same. By year five, all five are five-year CDs earning long-term rates, with one maturing every 12 months. You get regular access to a portion of the money without ever paying a penalty.
Laddering also removes the guessing game about rate direction. If rates rise, your next maturing CD gets reinvested at the new higher rate. If rates fall, most of your money is already locked in at the older, higher rates. One practical note: don’t open every rung at the same bank out of convenience. Rate differences between institutions can be half a percentage point or more, and that spread adds up over a five-year term.