Which certificate of deposit (CD) account is best for you?

9 min read

The traditional certificate of deposit account is the most popular type of CD. But it’s far from being the only option available to consumers looking for a safe place to park their cash.

Financial institutions offer a variety of non-traditional CD products. These specialized CDs can give savers more flexibility when interest rates are falling, provide early access to their funds or offer better-than-average rates of return. If you’re willing to sacrifice some yield or tolerate some additional risk, you might find a CD better suited to meet your financial needs.

What is a CD?

A CD is an account used for storing savings. Funds are held for a certain period of time, or term, often ranging from three months to as many as 10 years. The most common CD terms offered by most banks include the one-year, 18-month, two-year, three-year, four-year and five-year CDs.

With a CD your money may be locked up for an extended period of time. But there’s good news: You’ll likely earn a higher yield than you would if you opened a standard savings account or money market account. You’re guaranteed to earn interest at a predetermined rate. And you’ll earn that much interest as long as you avoid making a withdrawal before your CD matures.

There are many different types of CDs to choose from. While CDs typically come with fixed rates, bump-up and step-up CDs allow account holders to increase their yield before the end of the term. Zero-coupon, callable and high-yield CDs potentially give you the chance to earn a more competitive rate and jumbo CDs require a high minimum deposit. Brokered and liquid CDs offer more liquidity, while add-on CDs allow for multiple deposits, like savings accounts. Finally, IRA CDs simply give savers another place to keep their funds for retirement.

Carefully consider which type of CD is best for you.

11 types of CD accounts

Common CD Terms

1. Traditional CD

With a traditional CD, you deposit a fixed amount of money for a specific term and receive a fixed interest rate. You have the option of cashing out at the end of the term or rolling over the CD for another term. Most institutions don’t allow you to add additional funds before your traditional CD matures.

Penalties for early withdrawal can be quite stiff and will cause you to lose interest, and possibly principal. Federal regulation — Regulation D, specifically — sets only the minimum early withdrawal penalty for traditional CDs. There is no law preventing an institution from enacting tougher penalties, but the institution must disclose those fees when the account is opened.

Before you pick a CD, calculate how much interest you could earn by the end of your term.

2. Bump-up CD

bump-up CD helps you benefit from a rising-rate environment. Suppose you buy a two-year CD at a given rate, and six months into the term the bank offers an additional quarter-point on the same investment.

A bump-up CD gives you the option of telling the bank you want to get the higher rate for the remainder of the term. Institutions that offer this CD option usually allow only one bump-up per term.

The drawback is you may get a lower initial rate on a bump-up CD than on a traditional CD. The longer it takes interest rates to rise, the longer it will take to make up for the earlier, lower-rate portion of the term.

Be sure you have realistic expectations about the interest rate environment before buying a bump-up CD. See how bump-up CD deals stack up against traditional CD rates.

3. Step-up CDs

In a rising-rate environment, you might also want to consider a financial institution that offers a step-up CD.

It’s not uncommon to see a step-up CD and a bump-up CD lumped together. Both of them will help you move up to a higher yield. However, they are different products. Rather than requiring you to ask the bank for a higher rate as bump-up CDs do, step-up CDs will automatically increase their rates throughout their terms at certain intervals.

They are not too common, however. What’s more, there is a big caveat: There is no guarantee that you would end up better off than you would have if you had parked your money in a traditional CD. The blended APY could be less than you would make with a traditional CD. As such, you’ll want to evaluate the starting APY as well as how much the rate is increasing before making a decision.

4. Liquid (or no-penalty) CD

Liquid CDs, or no-penalty CDs, offer investors the opportunity to withdraw their money without incurring a penalty.

The interest rate tied to a liquid CD may be higher than that of a savings or money market account. But it will likely be lower than the rate associated with a traditional CD of the same term. You’ll have to weigh the convenience of liquidity against whatever return you’re sacrificing.

A key consideration when purchasing a liquid CD is how soon you can make a withdrawal after opening the account. Most banks require that the money stay in the account for at least seven days before it can be withdrawn without penalty, but banks can set the first penalty-free withdrawal for any time period. It’s important to read the fine print before opening a liquid CD.

5. Zero-coupon CD

These CDs are similar to zero-coupon bonds. As with the bond, you buy the CD at a deep discount to its par value (or the amount you’ll receive when the CD matures).

“Coupon” refers to a periodic interest payment. “Zero-coupon” means there are no interest payments.

So, you might buy a 10-year, $100,000 CD for $50,000, and you wouldn’t receive any interest payments over the course of the term. You’d receive the $100,000 face value when the CD matures.

One drawback is that zero-coupon CDs are usually long-term investments, and you take on considerable interest rate risk. If interest rates rise during the 10-year term, you’ll be on the losing end of that deal.

Another potential problem is that you’re credited with phantom income each year. No money is being put in your pocket, but you’ll have to pay Uncle Sam on the earnings being accrued. Each year, you’ll have a higher base than the year before — and a bigger tax bill. Make sure you have room in your budget to cover the taxes.

6. Callable CD

With a callable CD, you could get a higher yield than with traditional CDs but with a risk: The bank that issues the CD can “call” it away from you after your call-protection period expires, and before the CD matures. For instance, if you buy a five-year CD with a six-month call-protection period, the institution could call it back after the first six months.

Just as with the zero-coupon CD, the bank is shifting interest rate risk to you. If it issues a five-year CD at 3 percent and six months later rates drop by a full percent, the bank will drop its rate as well. It will now be paying 2 percent on the five-year CD you originally got at 3 percent.

The bank can call, or take back, your CD and reissue it at the lower 2 percent. You’ll receive your full principal and interest earned. But you’re stuck reinvesting your money at lower rates.

Usually, banks pay a premium for you taking on the risk that the CD may be called. They may pay investors a quarter- or half-percent more on a callable CD than they would on a CD without the call feature.

7. Brokered CD

brokered CD is a certificate of deposit sold through a brokerage firm. To qualify for one, you’ll need a brokerage account. Some banks use brokers as sales representatives to find investors willing to purchase the banks’ CDs.

Buying CDs through a brokerage can be convenient. There’s no need to open accounts at a variety of banks just to get the best CD yields. Brokered CDs may pay higher rates than CDs from your local bank because banks using brokered CDs compete in a national marketplace. But that’s not always the case.

Brokered CDs are more liquid than bank CDs because they can be traded like bonds on the secondary market. But there is no guarantee you won’t take a loss. The only way to guarantee getting your full principal and interest is to hold the CD until maturity.

Don’t assume all brokered CDs are backed by the Federal Deposit Insurance Corp. It’s up to you to do your due diligence and look for that FDIC seal on the broker’s website. You should also watch out for brokered CDs that have call options. And before you invest, check on fees and early withdrawal policies.

8. High-yield CD

Banks compete for deposits by offering better-than-average rates. High-yield CDs may offer two or three times the national average on a given term. These are generally traditional CDs that pay very generous returns. Bankrate offers the best route for finding the highest rates in the nation.

Bankrate surveys local and national institutions to find banks offering the highest yields on CDs. All accounts are directly offered to the consumer by the institution.

Take time to compare the best CD rates. Then calculate your potential earnings.

9. Jumbo CD

Just as its name implies, a jumbo CD requires a larger deposit than a traditional CD. To get one, you would typically need to make a minimum deposit of $100,000. In some instances, that deposit threshold will be somewhat lower.

While jumbo CDs could pay more than a traditional CD, they might not. A five-year jumbo CD on average pays 1.26 percent APY, while a five-year CD rate pays 1.23 percent as of late August, according to Bankrate’s national survey of banks and thrifts.

In putting tens of thousands of dollars into a jumbo CD, there’s a risk of whether the account will keep up with the inflation rate. Also don’t forget to consider your tax bite: The interest you earn will be taxed as ordinary income.

10. IRA CD

Individual retirement accounts hold investments. IRA CDs are IRAs where you invest in CDs.

IRA CDs may appeal to the risk-averse who are preparing to pad their retirement savings with guaranteed returns – you’ll know how much you’ll make over the product’s term so long as you keep the CD until its maturity. You will also have protection of up to $250,000 from the government if you purchase IRA CDs from an FDIC-insured institution. Translation: If the bank goes bust, your money won’t.

The trade-off is that you won’t make high returns on these investments. While they can help you diversify your portfolio, IRA CDs are not generally viewed as smart retirement strategies for younger investors, who can take on more risk.

Just like with the other CD types, make sure you shop around for the best yields. To effectively use an IRA CD, fund one with money you won’t need until age 59 1/2, so you don’t have to pay a tax on early distributions.

11. Add-on CD

Most CDs let you make only an initial deposit. But add-on CDs let you make multiple deposits into the account during the CD’s term. However, how many deposits you can make into an add-on CDs varies. So, make sure you read the fine print.

What is the best type of CD for you?

Though there are various types of CDs, many of them have something in common.

With most CDs, there’s an early withdrawal penalty that comes into play if you want access to your cash before the maturity date. And with many CDs, your interest rate is fixed for the length of your term. There’s virtually no risk associated with traditional, jumbo or IRA CDs, for instance, since you can easily calculate how much interest you’ll ultimately earn.

Since some CDs are distinct in terms of the benefits they offer, it’s best to consider the kind of situation that might warrant the purchase of that type of CD. With the liquid (or no-penalty) CD, for example, there’s no penalty for an early withdrawal.

Going with a no-penalty CD could make sense if you’re trying to lock up money for a specific goal when you’re unsure of exactly when you’ll need your cash. For example, if you’re afraid the stock market’s taking a turn for the worse, you can reduce the risk of losing too much money by locking some of it up temporarily in a liquid CD. When you find a better place to keep your cash, you could close out the CD without incurring a penalty.

When you’re thirsty for a higher yield, you might look to invest in a callable or zero-coupon CD. But considering the downsides and the current economic conditions is critical when looking into these types of products.

“Individuals that end up in callable CDs often end up there because they were sold something – like an attractive upfront yield – without knowing the back-end consequences,” says Greg McBride, CFA, Bankrate chief financial analyst. “If rates go up, the CD isn’t called and you’re stuck in a long-term, now lower-yielding CD. If rates go down, the CD gets called and now you get to reinvest in a lower-rate environment.”

Other CD strategies

Besides thinking about the kind of CD you’d like to include in your portfolio, it’s important to implement the right investment strategy to achieve your financial goals. Buying a single CD is an option, but you should also reflect on whether it makes sense to purchase multiple CDs at the same time.

CD laddering is a strategy that provides flexibility. It involves buying different CDs with different term lengths. For example, you could build a CD ladder by depositing $2,000 each into 12-month, 24-month and 36-month CDs. By laddering, you’ll consistently have access to liquid funds that you can reinvest or use for a different purpose. At the same time, you’ll have an opportunity to earn a higher yield by investing in CDs with longer terms that pay more interest.