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What is a Certificate of Deposit (CD) and How Does it Work?

Eve Chin, VP Deposit Planning and Strategy, First Republic Bank
August 27, 2021

For those looking to save money, most may go with a savings account. However, there is a unique option available to those who want their money to grow over time. A certificate of deposit (CD) is a valuable savings tool that often pays higher interest rates when compared to a typical savings deposit account.

It’s important to figure out how a CD works so you can decide if it is the right fit for your own unique monetary goals and resources.

How do CDs work?

A certificate of deposit (CD) is a time deposit account that pays a fixed interest rate over a period of time (generally ranging from 30 days to 5 years). Any early withdrawals of funds before the set maturity date come with a fee.

Typically offering higher interest than savings deposit accounts, CDs are a potentially great way to save for short- or long-term goals. In most cases, the longer the term of the CD, the higher the interest rate. CDs typically have no fees unless funds are withdrawn before the maturity date.

Are CDs Safe?

While having your money gain interest over time is enticing, some may worry about the safety of having their money in a CD. With a lump sum of money put away for possibly years, you want to ensure it’ll be there when you come to withdraw it. The good news is that the funds in your deposit accounts at a financial institution, including but not limited to CDs, are federally insured up to $250,000 per depositor by the Federal Deposit Insurance Corporation (FDIC), providing protection for your peace of mind. Safety is just one of many advantages a CD has to offer.

Different types of CDs

Not all CDs are created equal. There are several types of CDs available to those looking to save their money — each with special considerations that should be reviewed before choosing which one to use. A few of the types of CDs you may encounter include:

  • IRA CD: Some may use CDs to help save for retirement. Funds from an individual retirement account (IRA) invested into a CD is called an IRA CD.
  • Liquid CD: A liquid CD allows you to withdraw funds prior to maturity up to once (at least) every 7 days without incurring a penalty. However, the tradeoff is these CDs often pay lower interest rates.
  • Jumbo CD: A jumbo CD is a CD that requires a large minimum deposit — usually around $100,000. These often pay a higher rate of return tied to the large upfront deposit requirement. First Republic does not offer jumbo CDs.

Advantages of CDs

There are several advantages to saving with a CD. Learning the benefits of a CD as a viable savings tool is important to understand before opening one. This helps you feel more confident with your choice as well as ensures your money is working toward your financial goals.

  • Higher interest rates: Depending on the type of account, a CD will almost always yield a higher interest rate than other savings deposit accounts.
  • Safety: Funds in your deposit accounts at a financial institution, under the same ownership category are added together and are insured by the FDIC up to $250,000 per depositor, so you know your money is safe.
  • Predictable returns: In contrast with other investment vehicles, CDs offer predictable, guaranteed returns on the funds you put in. You set aside a specific amount at a fixed rate for a specific amount of time, so you don’t have to worry about performance.
    • For example, if you place $10,000 in a CD at 2.25% for 1 year, with interest compounded daily, you’ll know exactly how much you’ll have at the end of that year — $10,228, representing an annual percentage yield earned of 2.28%. Visit the First Republic CD calculator to see potential earnings at different interest rates and term lengths.

Disadvantages of CDs

While having a CD has its advantages, there are a few disadvantages to consider before setting one up.

  • Early withdrawal penalty: Money in a CD is locked for a set period and can only be withdrawn at maturity; otherwise, a significant early withdrawal penalty applies.
  • Due diligence: If your CD is longer than one month, your bank will likely inform you when your CD term is about to expire. If you somehow miss the notifications, your account could automatically roll over into a new CD, making it harder or more costly to access your cash before your new term limit is up. Be sure to monitor your CD to ensure you are able to access your money once it becomes available. First Republic clients can set up CD maturity reminders in Online Banking.

CD Versus Other Savings Tools

CDs are not the only savings option available to you. You should consider all the savings tools banks offer before choosing one to fit your financial needs and goals.

  • Savings account: A savings account is a common savings deposit type offered by banks. These are not transaction accounts and like any bank deposit, funds in savings accounts are FDIC-insured up to the applicable limits. Unlike CDs, interest rates for savings accounts can change at any time, after the account was opened, based on federal policies and market conditions.
  • Money market: A money market account is another type of savings deposit that offers benefits including limited check writing and limited transaction privileges. Like savings accounts, the interest rates for these accounts can also change at any time after the account was opened. However, you may be limited to six withdrawals a month.

First Republic offers both Money Market Savings, for those who want the benefit of attractive interest rates, and Money Market Checking accounts, for convenience of accessing funds via check or ATM Card while earning interest.

How do I know if a CD is right for me?

A CD offers a lot of positives, but it is important to understand all the details and conditions before signing on the dotted line. If you have unused funds earmarked toward a specific financial goal — such as buying a house, financing a loved one’s education or saving for emergency cash or for retirement — then the possibility of opening a CD should be explored. You may benefit from:

  • Low risk: A CD gives you the opportunity to explore new financial tools while having a portion of your money be secure while earning interest.
  • Potential for reward: If you have unused funds from a larger project, investing in a CD can give you some return on your funds.

However, remember that any early withdrawals before the maturity date will likely incur fees. If you want the flexibility of having immediate access your funds in an emergency situation, you may want to explore a shorter-term CD or opening a money market account or checking account instead.

Be sure to compare a CD with other savings tools to find out which type works best for your financial needs and timeline. The First Republic CD calculator can show you any potential earnings and APY you may get during the life of a CD. This may help inform your final decision.

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