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The traditional certificate of deposit is far from being the only CD product available to savers. Financial institutions offer a variety of CDs, giving savers more flexibility to manage their money when economic winds change. Since rates have risen significantly over the past year, it might be a good time to explore your investment options and consider the many varieties of CDs.
What is a CD?
A CD is a deposit account that generally pays a fixed interest rate over a set amount of time, or term.
Depending on the term and the bank, CDs may pay more interest than the average savings account or money market account. And CDs are insured up to $250,000 if taken out at a federally insured bank or credit union by an individual.
To open a traditional CD, the account holder makes a one-time deposit, then leaves the funds to grow until the CD matures. Common terms include three, six, nine and 18 months, along with one, two, three, four and five years. Closing a traditional CD before the term ends generally results in an early withdrawal penalty.
But there are many specialty CDs that don’t conform to the features of traditional CDs. Specialty CDs give savers more flexibility to take advantage of better rates, shield themselves when interest rates are falling and provide easier access to their funds without penalty. Carefully consider which type of CD is best for you.
1. Traditional CD
With a traditional CD, you make a one-time deposit that meets the bank’s minimum opening deposit requirement. The money stays with your bank for a specific term and earns 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. Penalties for early withdrawal can be stiff and will erode your earnings, and possibly your principal. Those fees must be disclosed when the account is opened.
Before you pick a CD, calculate how much interest you would earn by the end of its term.
2. Bump-up CD
A bump-up CD helps you benefit from a rising-rate environment. Suppose you open a two-year CD at a given rate, and six months into the term your bank raises the annual percentage yield (APY) on that product.
A bump-up CD allows you to tell your bank you want the higher rate for the remainder of the term. Institutions that offer bump-up CDs usually allow only one bump-up per term.
The drawback is that a bump-up CD typically has a lower APY than a traditional CD, so when rates rise, you’ll be catching up. It’s important to understand the interest rate environment before taking out a bump-up CD. See how bump-up CD rates stack up against traditional CD rates.
3. Step-up CDs
Like a bump-up CD, a step-up CD lets you move to a higher yield. But unlike a bump-up CD, you don’t have to ask the bank for the higher rate; a step-up CD rate rises automatically by a predetermined amount at certain intervals during the term.
Step-up CDs are uncommon, and there’s no guarantee that you will earn more than a traditional CD. With that in mind, you’ll want to evaluate the initial APY, as well as how much the rate can increase, before choosing this product.
4. Liquid (or no-penalty) CD
Liquid CDs, or no-penalty CDs, allow investors to withdraw money before the CD term ends — generally after the first six days — without incurring a penalty. The APY tied to a liquid CD may be higher than the yield on a savings or money market account, but it will likely be lower than the rate on 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 with 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 financial institutions can set their own penalty-free withdrawal rules, so read the fine print before opening a liquid CD.
5. Zero-coupon CD
With zero-coupon CDs, you buy the CD at a discount to its par value, which is its value at maturity. Coupon refers to a periodic interest payment, so zero-coupon means there are no interest payments during the CD term. For example, if you bought a 10-year, $100,000 CD for $85,000, you wouldn’t receive interest payments during the CD term. Instead, you’d receive the $100,000 face value and the accrued interest when the CD matures.
One drawback of zero-coupon CDs is that they are usually long-term investments and you don’t get the interest until the CD matures.
A bigger drawback is that you must declare the accruing interest as income each year and pay taxes on it, even though you can’t pocket the interest until the CD matures. Each year, you’ll have a higher base than the year before — and a bigger tax bill.
You can inquire about zero-coupon CDs at your bank, but you may have to go through a brokerage firm to get one.
6. Callable CD
With a callable CD, there is an opportunity to earn higher interest, but it comes with a risk: The issuer of a callable CD has the option to “call” back the CD after a set time, before it matures. Whether the issuer uses that option depends on the interest rate environment.
Let’s say you take out a five-year CD at a top rate and the bank has the option to call back the CD in one year. During that year, prevailing rates drop, so your bank also drops its rate on new five-year CDs. The bank can call back your CD and return your principal, plus the interest you’ve earned up to that point. But then you’re stuck with having to reinvest the money after rates have fallen.
When you’re seeking an initial higher yield, you might consider a callable CD. But weigh the downsides and economic conditions before choosing this type of CD.
7. Brokered CD
A brokered CD is sold through a brokerage firm. To get one, you need a brokerage account. Buying CDs through a brokerage can be convenient because you don’t have to open CDs at a variety of banks to get the best yields. Some banks use brokers as sales representatives for their CD products. Banks offering brokered CDs compete in a national marketplace, so they might pay higher rates, but not always.
Brokered CDs are more liquid than bank CDs because they can be traded like bonds on the secondary market. There’s no guarantee you won’t take a loss. The only way to guarantee getting back your full principal with interest is to hold the CD until maturity.
Don’t assume all brokered CDs are backed by the FDIC because not all brokerage firms partner with federally insured banks. Also, watch out for brokered CDs that are callable. Read the fine print before you invest, and check on fees and early withdrawal penalties and policies.
8. High-yield CD
Banks compete for deposits by offering better-than-average rates. High-yield CDs are generally traditional CDs that pay better 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.
9. Jumbo CD
Just as its name implies, a jumbo CD requires a larger deposit than a traditional CD — typically, around $100,000. In some instances, the deposit requirement is somewhat lower. Jumbo CDs may or may not pay more than a traditional CD. The average rate on a five-year jumbo CD is 1.30 percent, while the average rate on a standard five-year CD is 1.24 percent, as of April 5, 2023, according to Bankrate’s national survey of banks and thrifts.
10. IRA CD
An IRA CD is a CD that is held in a tax-advantaged individual retirement account. IRA CDs may appeal to the risk-averse who want to build their retirement savings with guaranteed returns. The trade-off is that you won’t earn high returns compared to what you could earn in stocks, but you could also lose money by investing in the market.
An IRA CD with an FDIC-insured institution is protected up to $250,000.
Though they can help you diversify your portfolio, IRA CDs generally aren’t viewed as smart retirement strategies for younger investors who are well positioned to take on more risk. To get the most out of an IRA CD, fund one with money you won’t need until age 59½, so you don’t have to pay a tax on early distributions.
11. Add-on CD
With most CDs, you make the initial opening deposit and can’t add money to it during the term. But add-on CDs let you deposit more money into the account during the CD term, like a savings account. The number of additional deposits you can make with an add-on CD varies, so be sure you read the fine print.
12. Foreign currency CD
Foreign currency CDs aren’t for novices or risk-averse investors. They are complicated. They can be issued in euros, British pounds and other foreign currencies. They’re bought with U.S. dollars and are converted back to dollars when they mature. There’s no guaranteed APY because the interest is based on a foreign currency or a basket of foreign currencies.
Investing in foreign currency CDs may yield higher returns, but currencies and global economic conditions fluctuate, creating risk. There are also risks when you convert the foreign currency CD back to U.S. dollars. A strengthening dollar can wipe out your return or result in you losing money.
Foreign-currency CDs might not be FDIC-insured. To qualify for FDIC insurance coverage, the principal amount you invest must be guaranteed by the issuing bank. “If the principal is subject to loss — other than for an early withdrawal penalty — the product is not insured by the FDIC if the bank were to fail,” the FDIC says on its website.
Other CD strategies
Besides choosing the right CD, it’s important to implement the right investment strategy to achieve your goals. Buying a single CD is an option, but it might make sense to purchase multiple CDs at the same time so that you can ladder them. CD laddering provides flexibility and involves buying different CDs with different term lengths.
For example, you could build a CD ladder by depositing $2,000 each into one-, two- and three-year 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.
— Bankrate’s Matthew Goldberg contributed to an update of this article.