Certificate of Deposit
Definition
A Certificate of Deposit (CD) is a guaranteed investment issued by banks and credit unions. Most CD offer fixed interest rates and over a predetermined period.
Detailed Explanation
A certificate of deposit is a low-risk savings vehicle offered by financial institutions, where an individual commits a certain amount of money for a fixed period of time, ranging from a few months to several years. In return, the issuing bank pays interest.
The interest rate on a CD is typically higher than that of a savings account because the funds are locked in and cannot be accessed by the holder without incurring a penalty until the maturity date. CDs are considered low-risk, stable investment options for saving money while earning interest. Upon maturity, the CD holder can either withdraw the funds along with the accrued interest or roll over the CD into a new term.
CDs are insured up to certain limits by the Federal Deposit Insurance Corporation (FDIC) in the United States, making them a safe way to save money. However, the interest rate is fixed, which means if rates rise, the holder still earns the original rate agreed upon at the time of opening the CD.
Example
Emily invests $5,000 in a 1-year CD with an annual interest rate of 2.5%. At the end of the year, she will have earned $125 in interest, making her total return $5,125 if she chooses to withdraw her investment or reinvest it in a new CD.
Key Articles Related To Certificates of Deposit (CDs)
Related Terms
Interest Rate: The proportion of a loan charged as interest to the borrower, typically expressed as an annual percentage of the principal.
Maturity Date: The final payment date of a loan or other financial instrument, at which point the principal (and all remaining interest) is due to be paid.
Savings Account: A deposit account held at a bank or other financial institution that provides principal security and a modest interest rate.
Time Deposit: A money deposit at a banking institution that cannot be withdrawn for a certain term or period of time unless a penalty is paid.
FAQs
What happens if I withdraw my money from a CD before the maturity date?
Withdrawing funds from a CD before its maturity date usually results in a penalty, which can diminish the earnings from interest.
How is the interest from a CD taxed?
If your CD is held in a taxable account, interest earned is taxable as income, either federally and, in some cases, at the state level, depending on where you reside.
Can I add more money to my CD?
Typically, you cannot add money to an existing CD. Once initiated, the deposit amount is fixed until the CD matures. However, you can open additional CDs with new deposits.
Editor: Colin Graves
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