How Does a CD Account Work?

When you open a certificate of deposit (CD), you agree to leave your money in the account for a set period of time. This can range from a few months to a number of years. In exchange, the bank or credit union will pay you a guaranteed return on the money, in some cases a higher interest rate than you'd get on a regular savings account.

If you're planning to make a big purchase in the next few years, you might consider putting some savings into a CD. A CD can be thought of as a federally insured savings account, but with a few key differences.

Before You Open A CD Account

A certificate of deposit is a relatively simple investment product and buying one is a straightforward process. Here are the key steps for buying a CD:

1. Decide How Much You Want To Invest

First, you should determine how much money you can invest in a CD. This is important because CDs are not very liquid—that is, you can't get your money out easily if you need it in an emergency. Because of this, you should only put money into a CD if you are fairly sure you aren't going to need it before the CD matures. CDs have early withdrawal penalties (more on that below), which makes them a bad choice for emergency savings or other money you might want at a moment's notice.

2. Determine What Kind of CD You Want

Many banks and credit unions in the U.S. offer at least one certificate of deposit and many have a wide array of them. You'll find CDs offered by nearby brick-and-mortar banks as well as from regional and national banks that accept customers online. Investopedia's regularly updated ranking of the best CD rates, for example, tracks over 200 financial institutions that offer CDs.

There are three main considerations when choosing a CD. The first is the term, or how long you are willing to leave your money in the CD before you can withdraw it. CD terms range from a few months to years. If you aren't sure when you're likely to need your money back, it's better to err on the side of caution. You can always choose a CD with a short term and then re-invest the money in another CD after it matures.

Interest rates are another consideration. Longer terms generally mean higher rates. But the range of CD rates can vary widely from one financial institution to another. The top-paying CDs in the country may pay many times the national average rate, so it's smart to shop around.

Finally, consider whether a standard or specialized type of CD would be best for you. Standard CDs pay a set interest rate and charge penalties for early withdrawals. There are other types that pay variable interest rates or that are more flexible, such as liquid CDs. In general, you'll pay extra for that flexibility by means of a lower interest rate.

After You've Opened A CD Account

Let's say you've purchased a CD. Then what?

1. Leave Your Money Alone

Now comes the (potentially) easy bit: leaving your money alone. Once you've signed up for a CD, the bank or credit union will give you instructions on how to transfer funds to the new account. Once you've made a deposit, try to resist the temptation to withdraw money before your CD matures, unless you face emergency expenses. 

2. Plan for When Your CD Matures

When your CD reaches the end of its term, you'll have some decisions to make. You will usually have three options:

• Roll the CD over into a new CD at that bank or credit union: You can choose a CD of the same term or a different one, if available.
• Transfer the funds into another account at that bank: Your options include savings, checking, and money market accounts.
• Withdraw the proceeds: You can ask the financial institution that holds your CD to transfer the money to an account at a different institution or mail you a check to deposit yourself.

If you don't provide any instructions before the bank or credit union's deadline, it will usually roll your CD proceeds into a new CD of the same term. If that's not your intention, missing the deadline could mean locking yourself into a CD with a subpar rate or paying an early withdrawal penalty to get your money out.

Frequently Asked Questions (FAQs)

The Bottom Line

Certificates of deposit (CDs) are different from other types of accounts offered by banks and credit unions. They typically pay higher interest rates but also require that you leave your money on deposit for a set period of time. Otherwise, you'll usually have to pay an early withdrawal penalty. Consider consulting with a financial professional to review investment options that meet your financial goals.