10 things you need to know before investing in CDs

Certificates of deposit (CDs) allow you to lock in the interest rate on your deposit for a set period of time. This is especially true in the current environment where CD production is higher than it has been in years.

But while the concept of CD yields is well known to most Americans, there is a lot more information about this type of bank account that many people may not be familiar with. For example, did you know that some banks require thousands of dollars to open a CD while others do not? And some CDs may be better at generating income than others.

With that in mind, here are 10 particularly important things to keep in mind when deciding whether CDs are the best place to store your cash.

1. Early withdrawal may result in disadvantages.

This isn’t exactly a secret, but it’s worth mentioning. When you open a CD, your money isn’t necessarily locked in the bank for the entire period, but you may have to pay a penalty if you take it out early. In most cases, the penalty is equivalent to several months’ worth of interest, and tends to be worse for long-term CDs than short-term CDs.

For example, if you have $10,000 in a CD with a 5% interest rate, an early withdrawal could cost you $125 because an early withdrawal could cost you three months’ worth of simple interest. In certain cases (such as financial hardship), banks may waive CD penalties, but this is rare.

2. There are special CDs that may be attractive.

Some banks offer non-standard CD products that may suit your needs. For example, there are several banks that offer penalty-free CDs. CDs allow you to deposit APY for certain months but don’t incur a penalty if you withdraw the money early.

There are also step-up CDs (the name may vary from bank to bank) that allow you to adjust the interest rate at any time during the term. That means, if you get a step-up CD with a 5% APY and a few months later your bank offers 6% APY on the same CD, you can choose to reset the interest rate to the latter.

3. APY is only part of the equation.

If annual percentage yield (APY) was the only factor you considered, choosing a CD would be easy. But that’s not the case. Also consider the following:

• Does your bank offer other products that you use or are interested in? It can be convenient to keep your financial accounts in one place.
• How often is interest compounded on my account?
• How easy is it to manage your account? Does your bank have a good mobile app, branch, or other way to easily get help when you need it?

4. Many banks have minimum deposit requirements.

Most online banks have eliminated minimum deposit requirements for checking and savings accounts, but many still use them for CDs. The banks on our list of best CDs have minimum deposit requirements ranging from $0 to $2,500. So if you’re using a relatively small amount to open your first CD, check whether the bank you choose has a suitable minimum deposit amount. .

5. CDs come in standard terms (and some others).

Standard terms for CDs are 6 months, 9 months, 1 year, 18 months, 24 months, 3 years, 4 years, and 5 years. Most banks that handle CDs offer these terms. Some banks offer non-standard terms (e.g. 13 or 17 months) and in some cases these “promotional” periods may give you the highest returns.

You can also find CDs with fairly long dates. We looked for CDs with a maturity period of 10 years, which may be attractive to individuals who want a steady stream of income over the long term.

6. Some CDs allow you to withdraw your interest.

Money deposited in a CD cannot be withdrawn without penalty until maturity. However, some banks allow customers to withdraw the interest earned on their accounts. Although not all banks offer them, CDs can be a great tool for creating a steady stream of income in retirement.

7. CDs are FDIC insured.

As long as CDs come from a legitimate financial institution, they receive the same FDIC insurance as a checking or savings account. Money held in CDs at FDIC-insured banks is protected up to $250,000 per person. And if that’s not enough, you can open a CD at another bank to make sure all your money is safe.

8. The CD will be automatically renewed.

You may be surprised to learn that when your CD term expires, your account will automatically renew for another term (usually the same term) if you do not take action. Most CDs have a specific period of time during which you can choose not to renew before expiration, with one week being a typical grace period. However, if you don’t take action, it will renew whatever your bank’s current APY is at the time.

9. CD interest is taxable.

One important thing to know is that interest paid on CDs is considered taxable interest income. Even if you don’t withdraw. That means if you put $10,000 into a 2-year CD at 5.00% APY, you’ll earn $500 in interest the first year. And even if you leave it in the account to compound interest, you’ll still receive tax documents at the end of the year.

10. You can open CDs in your IRA.

As mentioned earlier, CD interest is taxable income. But there is a way around it.

If you open a CD in your Individual Retirement Account (IRA), you don’t have to pay taxes on the interest you earn each year. If you own a CD in a traditional IRA, you can take a tax deduction for your contributions, but when you ultimately withdraw money from the account, it will be taxable income. You don’t get an initial tax break with a Roth IRA, but you do get interest income. and Final withdrawals may be completely tax-free.

conclusion

As you can see, there’s more to CDs than simply opening an account, depositing money, and sitting back and earning interest. CDs can certainly be a good idea for many people, but it’s important to know exactly what you’re interested in first.