A certificate of deposit is a bank deposit with a bargain built in: you promise to leave the money for a fixed term, and the bank promises a set rate. Break the promise and you pay a penalty. Everything else about a CD, from the variations banks sell to the renewal notice and the tax bill, follows from those three terms, so this guide takes them one at a time. For the wider set of low-risk choices, see the safe investments hub.
What is a CD and how does it work?
A CD is an insured deposit that pays a fixed rate for a set term, usually from three months to five years or more.
You deposit a lump sum, the bank fixes the rate and the maturity date, and the money stays put until that date. Federal rules call this a time deposit: under Regulation D, money cannot leave within six days of deposit unless the bank charges at least seven days' simple interest. Credit unions sell the same product, often called a share certificate.
CDs carry the same insurance as other deposits. At a bank, FDIC coverage is $250,000 per depositor, per insured bank, per ownership category; at a credit union, NCUA coverage is $250,000 per share owner, per insured credit union, for each account ownership category. Rates vary widely. The FDIC's deposit-weighted national average is 1.76% (FDIC, as of Nov 1, 2026) for a 12-month CD and 1.41% for a 60-month CD, against 0.38% for savings, and competitive offers run well above those averages.
Regulation DD makes the bank put the key terms in writing before you open the account. The ones that decide how a CD behaves are these:
| Term | What to look for | Rule behind it |
|---|---|---|
| Rate and APY | Both must be stated; compare CDs on APY | Regulation DD, 1030.4 |
| Compounding and crediting | How often interest compounds and when it is paid | Regulation DD, 1030.4 |
| Early withdrawal penalty | Whether one applies and how it is calculated | Regulation DD, 1030.4; Regulation D minimum |
| Renewal | Whether the CD renews automatically, and the grace period | Regulation DD, 1030.4 and 1030.5 |
| Call feature | The date or circumstances under which the bank can redeem it | Regulation DD, 1030.4 |
How does a CD pay interest?
A CD pays interest on a schedule the bank discloses: it either compounds inside the CD until maturity or is paid out to you at set intervals.
The APY assumes the interest stays in until maturity, so a CD that pays interest out must say that withdrawing it reduces earnings. The difference is real but small on short terms.
Worked example: A $20,000 12-month CD at 3.85%
- Interest compounded monthly and left in the CD: (1 + 0.0385 ÷ 12) ^ 12 − 1 = 3.92% APY, or $783.73 at maturity
- Interest paid out each month instead: $20,000 × 0.0385 ÷ 12 = $64.17 a month, or $770.00 for the year
- Cost of taking the interest out: $13.73, the compounding you give up
Market-linked CDs, whose return depends on a stock index or another benchmark, often accrue interest only at maturity, the FDIC warns, and most cannot be cashed early. The math that turns a rate into an APY is covered in APY vs APR.
How are CD early withdrawal penalties calculated?
The bank sets the penalty, often as a number of days or months of interest, and federal law fixes a minimum but no maximum.
The floor comes from Regulation D: money withdrawn within six days of deposit must forfeit at least seven days' simple interest, which is $8.05 on $10,000 at 4.20%. Past that point the account agreement governs, and the OCC notes that federal law sets no upper limit. Regulation DD requires the agreement to say how the penalty is figured, for example as a number of months of interest, and a penalty larger than the interest earned so far comes out of your principal.
Worked example: Six months of interest on a two-year CD
You put $10,000 in a two-year CD at 4.20%, and the penalty is six months of interest: $10,000 × 0.042 × 6 ÷ 12 = $210. Simple interest keeps the arithmetic clear; compounding would shift each figure by a few dollars.
| Withdraw after | Interest earned | Penalty | You get back | Annualized return |
|---|---|---|---|---|
| 4 months | $140 | $210 | $9,930 | −2.10% |
| 9 months | $315 | $210 | $10,105 | 1.40% |
| 15 months | $525 | $210 | $10,315 | 2.52% |
| 24 months, at maturity | $840 | none | $10,840 | 4.20% |
The four-month row is the trap: the penalty exceeds the interest, so $70 of the deposit is gone. If you do pay a penalty, the bank reports the full interest on Form 1099-INT with the penalty shown separately, and IRS Publication 550 lets you deduct the penalty as an adjustment to income on Schedule 1 of Form 1040.
When does breaking a CD early pay off?
Only when the extra interest from a new, higher rate over the remaining term is larger than the penalty you pay to get out.
Break-even new rate = old rate + penalty ÷ (balance × years remaining)
Worked example: Rates rise six months into the two-year CD
Six months in, a new 18-month CD pays 5.20%. Breaking the 4.20% CD costs the $210 penalty.
- Staying put: $840 of interest over the full two years
- Switching: $210 earned, minus the $210 penalty, plus $10,000 × 0.052 × 1.5 = $780 on the new CD, or $780 in total
- Break-even: 4.20% + $210 ÷ ($10,000 × 1.5) = 5.60%; any new rate below that loses money compared with staying
The longer the penalty and the shorter the time left, the higher the bar. Regulation D also lets banks skip the federal minimum penalty after an owner's death, after a court finds an owner legally incompetent, and for certain IRA withdrawals, including those after age 59½. Whether the bank waives its own penalty in those cases is up to the account agreement.
What are no-penalty, bump-up and step-up CDs?
They trade the plain CD's fixed bargain for flexibility: a no-penalty CD lets you leave early, and bump-up and step-up CDs let the rate rise.
- No-penalty CD. The rate is fixed, but you can withdraw without a penalty after the first six days, the window in which Regulation D still requires one. Compare its rate with the same bank's standard CD and savings rates, and check whether partial withdrawals are allowed.
- Bump-up CD. You may ask to raise the rate to the bank's current rate for your term, as many times as the agreement allows, in exchange for a lower starting rate. It wins only if rates rise early enough.
- Step-up CD. The rate rises on a preset schedule. Regulation DD requires a single composite APY for the whole term, and that figure, not the final step, is the one to compare.
| Two-year CD, $10,000, simple interest | Rates rise to 4.50% after 8 months | Rates do not rise |
|---|---|---|
| Bump-up CD starting at 3.90% | $860 | $780 |
| Standard CD at 4.20% | $840 | $840 |
Worked example: A three-year step-up CD against a flat CD
The step-up CD pays 3.60% in year one, 4.00% in year two and 4.60% in year three, compounded annually. A standard three-year CD pays 4.10%.
- Step-up growth: 1.036 × 1.040 × 1.046 = 1.12700, so $10,000 earns $1,270.02
- Composite APY: 1.12700 ^ (1 ÷ 3) − 1 = 4.07%
- Flat CD: $10,000 × (1.041 ^ 3 − 1) = $1,281.12, which beats the step-up despite the step-up's 4.60% headline
What is a callable CD?
A callable CD lets the bank end the CD early on set dates and repay your principal plus accrued interest, which it tends to do after rates have fallen.
Only the bank holds the call; you cannot use it to leave. Regulation DD requires the date or circumstances of a possible call to be disclosed, and the SEC's investor guidance warns that a CD described as "one-year non-callable" may run much longer: the label only means the bank cannot call it during the first year. The FDIC puts the cost plainly: a callable fixed-rate CD can undermine your ability to lock in a long-term rate. Suppose a five-year callable CD pays 4.60% when a noncallable one pays 4.25%. If rates drop and the bank calls it after a year, and you reinvest the remaining four years at 3.25%, your five-year average falls to about 3.52%. The extra 0.35 point is payment for a risk that lands exactly when reinvesting is worst. Calls on CDs bought through a broker work the same way; see brokered CDs explained.
What happens when a CD matures?
At maturity you can withdraw, move or renew the money; an automatically renewing CD rolls into a new term unless you act within the grace period.
Regulation DD sets the notice rules. For an automatically renewing CD with a term longer than one month, the bank must send a notice at least 30 calendar days before maturity, or 20 days before the grace period ends if that period is at least five days long. For terms over one year the notice repeats the full account terms, and if the new rate is not yet known it gives the date it will be set and a phone number to ask. A CD longer than one year that does not renew needs a notice at least 10 days before maturity.
The renewal rate can be higher or lower than the old one, and the FDIC suggests checking whether renewal happens at the old rate or at the current rate. The grace period's length is set by the bank and disclosed. Regulation D also permits withdrawals within ten days after maturity without the federal minimum penalty, even when the CD has renewed. Before the date arrives, decide on the next step, compare the renewal rate with other offers and check that the new term is the one you want. Spacing maturities so that one comes due each year is the idea behind a CD ladder.
How is CD interest taxed?
CD interest is ordinary income in the year it is credited and available to withdraw without a substantial penalty, even if you leave it in the CD.
Banks send Form 1099-INT when interest reaches $10, but smaller amounts are still taxable. For a CD longer than one year that pays all of its interest at maturity, IRS Publication 550 treats the interest as original issue discount: you include a share each year and the bank reports it on Form 1099-OID.
Worked example: A three-year CD that pays at maturity
You buy a $20,000 three-year CD at 4.00% APY that pays everything at maturity. Using annual compounding for simplicity, the interest you report is:
- Year 1: $20,000 × 0.04 = $800.00
- Year 2: $20,800 × 0.04 = $832.00
- Year 3: $21,632 × 0.04 = $865.28
- Total: $2,497.28, taxed in three pieces although the cash arrives only in year three
CD interest is taxable by states as well, unlike interest on Treasury bills, which is exempt from state and local income tax; are T-bills taxable and T-bills vs CDs work through what that is worth. Tax rules change, so check the current IRS guidance or a tax professional for your own situation.
What are the risks of a CD?
A CD's main risks come from being locked in: penalties if you need the money early, rates that rise after you commit, and inflation that outruns the fixed rate.
- Liquidity. A penalty can exceed the interest earned, as the four-month withdrawal above shows, so CDs suit money with a known date rather than an emergency reserve.
- Rising rates. A locked rate cannot follow the market up, and getting out is worth it only above the break-even rate.
- Inflation. Consumer prices rose 3.74% in the 12 months to September 2026, by the BLS's CPI-U. A 4.20% CD keeps about 0.44% after inflation and before tax, and a CD at the FDIC's 1.76% October 2026 average for 12 months loses purchasing power. See real returns and inflation.
- Calls and renewals. A callable CD can be cut short when rates fall, and an unattended CD can renew at a rate or term you did not choose.
- Insurance limits. Accrued interest counts toward the limit, and a new CD adds to any deposits you already hold at the same bank in the same ownership category.
- Sales pitches. FINRA warns that eye-catching CD rates are sometimes bait for annuities or other higher-commission products, and the FDIC flags CDs far above market rates and products from companies that are not insured banks.
- Tax timing. Multi-year CDs can create taxable income years before the cash arrives.
Several of these risks shrink when maturities are spread out, which is the job of a CD ladder. If you need the money to stay reachable at a variable rate instead, compare how high-yield savings accounts work.