Certificate of Deposit (CD)

A Certificate of Deposit (CD) is what most people commonly call a time deposit. A CD is issued by a bank with a set deposit amount and a fixed term, such as three months, six months, one year, or five years. For example, a 1-year CD means you generally need to leave the money in place for one year before withdrawing it. If you take the money out early, you may lose part of the interest. The interest rate is set when you buy the CD, and that rate stays in effect until the term ends.

Here is a general overview of CDs, and below we will go through each part in more detail:

  • Yield: 2%-4% (fixed after purchase)
  • Risk: Basically none (FDIC coverage up to $250,000)
  • Flexibility: Low (you need to keep the money in for the stated term)
  • Payout Frequency: Monthly, semi-annually, or at maturity
  • Fees: None
  • Taxes: Interest income tax

How to Buy and Sell

CDs are issued by banks, but unlike a Saving account, CDs can be purchased not only directly from a bank but also through third-party platforms. For example, some brokerage accounts let you buy CDs from many different banks. I personally use Schwab. Other solid all-in-one platforms include Fidelity, Merrill, Ally, and Vanguard.

Compared with buying directly from a bank, another advantage of using these platforms is that you can sell your CD on the platform’s secondary market. So even if the CD has not matured yet, you may still be able to sell it at a good price if market conditions are favorable.

Yield

Below are the CD rates I found in Schwab on August 19, 2022. Rates ranged from 2% for a 1-month CD to 3.45% for a 5-year CD, which is quite good. For example, the 2.018% shown for a 1-month CD means that among all banks offering 1-month CDs, the highest available rate was 2.018%. Of course, some banks offered lower rates.

If you click in, you can see the list of banks. For example, when I clicked on the 1-year CD, I could see all of the details. Here is a quick explanation of the terms shown:

  • Coupon: stated interest rate
  • Coupon Frequency: how often interest is paid, such as Monthly, Semi-annually, or at Maturity
  • Maturity: maturity date
  • APY (%): annual percentage yield

Whatever rate is listed when you buy the CD is the interest you will ultimately receive. It does not change.

So how should you choose? You can simply pick the highest rate for the term you want. Or if the rates are similar, you can just choose a bank name you like. Of course, you should also consider things like the interest payment schedule.

Risk

A CD is still a bank product. No matter which platform you use to buy it, as long as the issuing bank is FDIC-insured, the CD is protected as well. When trading at Schwab, you can also see the label “CD from FDIC-insured banks.” So in general, loss of principal is not a concern. The main thing to watch is that coverage is capped at $250,000 per account.

If you buy a CD issued by a U.S. credit union, it is not covered by the FDIC. Instead, it is insured by the NCUA, also up to $250,000.

Flexibility

A plain CD is not very flexible. As mentioned earlier, some CDs do not pay interest until maturity. If you redeem early, you may lose part or even all of the interest.

However, because brokerage platforms have a secondary market, you can sell the CD there directly. You may have to pay some fees, and the price will generally be lower than the full principal-plus-interest amount you would receive at maturity. So there is still some flexibility. In the Schwab account interface, you can see the market value of the CD you bought.

You can then enter a bid and see whether anyone is willing to buy it.

Fees

There are no extra fees for holding a CD. Of course, if you want to trade it on the secondary market, there may be some transaction fees.

Taxes

For tax purposes, CD interest is reported on Form 1099-INT. You simply report the interest as income, and it is added directly to your total income. Depending on your income level, the tax rate can range from 10% to 37%. Since different CDs pay interest at different times, you only need to look at the total amount of interest paid during that tax year. If the CD pays only at maturity, then you report the interest in the tax year when you receive it at maturity. Note that for nonresidents (for example, students who have not yet been in the U.S. for 5 years), there is no tax on bank deposit interest.

If you trade a CD on the secondary market, then the income is no longer treated as interest income. Instead, it becomes capital gain, and the tax reporting is similar to stocks. Capital gain is divided into long-term and short-term, with different tax rates. For more details, see:

Summary

A CD lets you lock in your rate and comes with FDIC insurance, so it can work well as a medium-term financial planning tool. I recommend putting some of the money you will not need for a while into CDs as a low-risk fixed-income investment. You can also build a CD ladder with multiple terms, such as 3 months, 6 months, and 1 year, to add flexibility. Using a third-party investment platform is a good option, since you can still trade the CD on the secondary market if you end up needing the money.

For other low-risk ways to manage your money, see: