Interest is accrued on a CD daily: the bank multiplies your current balance by the annual nominal rate, divides by 365, and posts that day’s interest to the account. On a set schedule — often daily, sometimes monthly — that accrued interest is folded back into your principal, so the next day’s calculation runs on a slightly larger balance. When the interest actually becomes money you can spend depends on the crediting schedule, which is a separate thing from compounding and often causes confusion.
The Daily Accrual Math
Accrual starts the day you fund the account. Take the current principal, multiply by the annual nominal rate, and divide by 365. That’s one day’s interest. A $10,000 CD at a 5.00% nominal rate earns about $1.37 on day one ($10,000 × 0.05 ÷ 365). The same calculation runs every day of the term.
On its own that’s just arithmetic. What turns daily accrual into meaningful growth is compounding, which decides how often the running total of accrued interest merges back into the principal that the next day’s calculation uses.
Compounding Is Not the Same as Crediting
These two words get treated as synonyms, and they aren’t.
Compounding happens internally on the bank’s ledger. When accrued interest is compounded, it joins the principal and starts earning interest itself. With daily compounding, the $1.37 you earned today gets added to your $10,000 balance tonight, so tomorrow’s daily accrual runs on $10,001.37. Monthly compounding waits until the end of the month to do the same thing. The daily version produces a slightly higher return over time because the principal grows more often.
Crediting is when the bank makes that interest available to you as the account holder. Some CDs credit interest monthly or quarterly by sweeping it into a linked checking or savings account. If you take that option, the CD’s principal stays flat for the entire term, because interest leaves as soon as it’s credited. Other CDs credit interest only at maturity, so you see nothing until the term ends. The arrangement that produces the most growth is one where credited interest stays inside the CD and compounds alongside the original principal.
The disclosure documents at account opening spell out both frequencies, and they don’t have to match. A CD can compound daily and credit quarterly. If maximizing the return matters to you, look for CDs that compound daily and keep the interest inside the account rather than paying it out.
Nominal Rate vs. APY
Every CD carries two rate numbers. The nominal rate is the straightforward annual interest rate the bank quotes. The Annual Percentage Yield, or APY, is what you actually earn once compounding is factored in. Because compounding lets 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 offers can be compared consistently across institutions.1eCFR. Appendix A to Part 707, Title 12 – Annual Percentage Yield Computation The formula accounts for compounding frequency, so a 5.00% nominal rate compounded daily produces a higher APY than a 5.00% rate compounded monthly. When you’re comparing CD offers, compare APYs, not nominal rates.
The rate locks in when you open the CD. The bank cannot change it during the term regardless of what happens to market rates. That lock is the entire trade in a CD: you give up access to the money in exchange for a guaranteed return on it.
You May Owe Tax Before You Ever Touch the Interest
CD interest is ordinary income, taxed at the same marginal rate as wages.2Internal Revenue Service. Topic No. 403, Interest Received When you owe tax on that interest depends on how your CD is structured, and there is one specific structure that surprises 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 account earns $10 or more.3Internal Revenue Service. About Form 1099-INT, Interest Income The $10 threshold comes from the federal information-reporting statute for interest payments.4Office of the Law Revision Counsel. 26 USC 6049 – Returns Regarding Payments of Interest
The trap is longer-term CDs that don’t pay interest out at least annually. The IRS treats the deferred interest as Original Issue Discount, and you must include the OID in income as it accrues each year, even though the money is still locked inside the CD.5Internal Revenue Service. Publication 1212, Guide to Original Issue Discount (OID) For those accounts the bank sends a Form 1099-OID.6Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Practically, that means an annual tax bill you have to pay out of other funds. If you’d rather not deal with OID, look for multi-year CDs that credit interest at least annually.
If you pay an early withdrawal penalty during the year, the full interest earned still shows up as income on your 1099-INT. The penalty itself is deductible as an adjustment to income on Schedule 1 — an above-the-line deduction you can claim whether or not you itemize.
Reaching the Interest Before Maturity
Pulling money out of a CD before its maturity date triggers an early withdrawal penalty. Federal rules set only a floor: for withdrawals within the first six days after deposit, the penalty must 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 is no federal cap, and each institution sets its own schedule.8eCFR. 12 CFR Part 1030 – Truth in Savings (Regulation DD)
In practice, penalties commonly run between three and six months of interest, with longer terms carrying steeper penalties. Some institutions charge a full year of interest on five-year CDs. If the penalty is larger than the interest the CD has earned so far, the bank takes the difference out of your original principal. Cash out too early and you can walk away with less than you deposited.
Most CDs also require you to withdraw the entire balance; partial withdrawals are uncommon. The interest is accruing every day, but reaching it early is expensive by design.
What Happens at Maturity
When the CD reaches its maturity date, all accrued interest becomes yours without penalty, and a short grace period opens, typically seven to ten calendar days.9Bankrate. What To Do When a CD Matures During that window you can withdraw the full balance, move it to another account, or roll it into a new CD at whatever rate is currently offered.
If you do nothing, most banks automatically renew the CD into a new term of the same length at the prevailing rate, which may be well below the rate you originally locked. Set a reminder a few days before maturity so the decision is deliberate rather than default.