A certificate of deposit (CD) account is a low-risk savings account with a fixed period and interest rate. A CD account ensures guaranteed returns and little risk, making it ideal for short- and medium-term savings, typically ranging between three months to five years. During this period, account holders will benefit from higher-than-average savings rates, but their money can't be accessed until the fixed term ends.
How does a CD account work?
In exchange for depositing a set amount of money and agreeing not to access it during the fixed term, CD account holders will earn a guaranteed interest rate, typically more than an average savings account, and be protected against shifts in the financial market. For additional certainty, CDs offered by banks are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC).
This certainty means that CD account holders know exactly when their savings will mature and how much interest it will have accrued. While CD accounts typically have no fees, there may be minimum deposit requirements depending on the length of the term.
The interest on a CD account is compounded, making it important to understand the difference between interest rate and annual percentage yield (APY) when calculating your expected returns. Use our CD Interest Calculator to see how much you could earn at maturity. Interest is typically paid monthly but will vary between lenders and account types.
When your CD matures, you can withdraw your funds and interest. Some accounts will automatically renew and lock in for another year after a grace period, so check the terms of your account carefully to avoid any surprises.
When is opening a CD a good idea?
CD accounts are ideal for securing a good savings rate on any amount you can afford to lock away for an extended period.
Opening a CD account is generally suitable for people who are saving for the following reasons, as the money will not need to be accessed in the short term:
- A fund for your children's education
- Holiday savings
- Downpayment for a house
- Buying a new car
How are CD earnings taxed?
The interest earned on a CD account is taxed in the same way as ordinary income. Investors should consider how much tax will be due when deciding whether opening a CD account is the best option for them.
Can you lose money on a CD?
It is unlikely that you would lose money with a CD; however, taking your money out before the account matures will result in an early withdrawal penalty.
The penalty amount will vary between lenders and depend on the deposit agreement's length: a six-month account may have a penalty of 90 days, while a three-year account could charge around 365 days of interest for early withdrawal.
What are the advantages and disadvantages of a CD account?
Certificates of deposit are a popular option for savers looking for security and low-risk investments. Still, many factors determine whether a CD account is right for you. Here are the advantages and disadvantages of CD accounts:
Advantages of CD accounts
- Higher than typical savings rates – One of the biggest benefits of CD accounts is that account holders can earn more interest than a standard savings account.
- Fixed rates – CD account holders know exactly how much their yield will be and when it will be accessible.
- Wide range of terms – A wide range of terms are available – from a single month to 10 years, allowing savers to find the CD account that best suits their needs.
Disadvantages of CD accounts
- Lack of access to funds – CD accounts are not ideal for savers who also require liquidity and should only be used to save funds that will not need to be accessed -even in an emergency.
- Inflation risks – Locking into a fixed-rate savings account can risk the investment losing purchasing power if inflation shifts during the account's term.
- Tax applicable to interest – Interest from CD accounts is not tax-free.
Types of CD account
There is a broad range of CD account types for different circumstances and uses. If you are deciding between different types and terms of CD accounts, try using our CD Savings Calculator to compare.
First Merchants offer two types of CD accounts:
- Traditional CD: Traditional CD accounts offer higher yields than typical savings accounts and are available with various terms. Minimum deposits start at $1,000 for terms of 12 months or more or $2,500 for terms of less than a year.
- Smart Saver CD: Smart Saver CDs make saving simpler. Rather than a large lump sum, savers can automatically deposit a small amount each month, with a minimum deposit of $25.
Check out our latest special rates and CD account offers.
What is a CD ladder?
A popular way to benefit from higher interest rates without limiting access to most of your savings is to create a CD ladder, which splits your investment into multiple accounts with staggered maturation dates.
This approach means that a portion of your investment is always close to being accessible without penalty.
Learn more in our 'What is a CD ladder?' guide.
Find out if a CD account is right for you.
For more information about opening a CD account with First Merchants, call us at 1.800.205.3464 or contact us.
