Exploring Different Types of Certificates of Deposit (CDs)

A certificate of deposit (CD) is a unique savings account offered by banks and credit unions, distinct from traditional savings accounts. CDs typically offer higher interest rates because you must leave your funds in the account until its specified maturity date. However, traditional CDs are not the only option available. Financial institutions offer a variety of CD types, each with its own features and benefits. In this blog, we will explore seven types of CDs to help you determine which may best suit your savings goals.

Traditional CDs

A traditional certificate of deposit is the standard CD account with a fixed-term maturity period, typically ranging from three months to five years or longer. In return for leaving your money in the account, the financial institution pays you interest, usually at a higher rate than a traditional savings account. Generally, the longer your CD term, the higher your yield.

Traditional CDs are a reliable savings option because they are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000 per owner, making them a safe choice for savings. However, the biggest drawback is that your money is tied up. If interest rates rise or you need to withdraw funds for an emergency, you could incur penalties or miss out on potential earnings.

No-Penalty CDs

No-penalty CDs, also known as liquid CDs, allow you to make withdrawals before the CD’s maturity date without triggering a penalty. This flexibility makes them similar to a savings account but with a fixed interest rate. The annual percentage yield (APY) on a no-penalty CD usually lags behind that of a traditional CD, but the ability to withdraw funds without penalty can be a significant advantage.

No-penalty CDs are attractive to savers who want the flexibility to move their funds if interest rates rise before the CD matures. Conversely, if interest rates drop, you can rest easy knowing your funds continue to earn at a higher, fixed yield.

Jumbo CDs

Jumbo CDs, also known as high-interest CDs, offer higher interest rates than traditional CDs but require a much larger minimum deposit, typically at least $100,000. Like standard CDs, jumbo CDs have a fixed interest rate and a designated maturity date. The most significant advantage of a jumbo CD is the higher interest rate due to the larger deposit, allowing you to earn more on your investment.

Jumbo CDs are most beneficial for those with significant savings and large deposits seeking a low-risk investment. However, be aware that jumbo CDs, like other types of CDs, are insured by the FDIC up to $250,000 per account holder per bank. This means large deposits over that amount may only be partially insured.

Bump-Up CDs

With a traditional CD, the interest rate remains the same until its maturity date. However, bump-up CDs allow you to change your interest rate if the CD issuer raises the rate on the same term CD after yours is opened. This feature can help you take advantage of rising interest rates during your CD’s term.

Most CD issuers only allow you to exercise this option once, but some long-term CDs may allow for more adjustments. Bump-up CDs often offer lower rates than CDs that don’t feature a rate adjustment, so it’s essential to shop and compare rates to ensure you’re getting a competitive yield.

Step-Up CDs

Step-up CDs require you to leave your money in the deposit account for a fixed period at a specific interest rate, similar to bump-up CDs. However, with step-up CDs, the increase in interest rate is automatic and happens at scheduled intervals, such as every six months or annually.

A step-up CD can be a good option if you anticipate interest rates will rise during your CD’s term since it guarantees a periodic rate increase. The primary drawback is that the starting interest rate can be lower than a traditional CD, so if interest rates don’t rise, you could earn less over the term of your CD.

Brokered CDs

Brokered CDs differ from most types of CDs because you must purchase them through a broker or brokerage firm, not a bank or credit union. These CDs offer numerous benefits, such as higher yields than standard CDs and the ability to hold multiple CDs in one brokerage account. Additionally, you may be able to access your money before your CD matures since brokered CDs let you sell the CD on the secondary market without a penalty.

As with most investment assets, brokered CDs carry a certain degree of risk. The brokerage’s CD purchase from the issuing bank is FDIC insured, but your CD purchase might not be. Another downside to brokered CDs is that they may be callable, meaning the issuing bank can end the CD before its maturity date. In such a scenario, you wouldn’t lose your deposits and earnings to date, but you would lose out on potential future earnings.

IRA CDs

IRA CDs can be opened and held within an individual retirement account (IRA) to receive higher interest rates than other savings vehicles and the tax advantages of an IRA, such as tax-deferred or tax-free growth. You can add new funds or roll over funds from an existing retirement plan, with IRS annual contribution limits applying to new funds.

IRA CDs are suitable for those confident they won’t need to access the funds until retirement. Both a CD and an IRA restrict access to account funds until a future date, and making an early withdrawal could result in penalties from both the CD and the IRA.

The Bottom Line

Deciding which CD is best for you depends on your unique financial situation and goals. CDs may benefit you if you have a significant amount of money you won’t need anytime soon. They offer higher earnings than a traditional savings account and come without the increased risks of stocks and bonds investing.

Before signing up for any CDs, ensure you understand the terms by which you can access account funds if needed. The last thing you want is to incur penalties that offset your earnings if you need to withdraw funds from your CD. If you want higher earnings and the flexibility to access your money in a pinch, consider getting a high-yield savings account from an online bank. These accounts offer rates comparable to most CDs, but often 10 times higher than a traditional savings account.

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