Debunked: Common Certificate of Deposit (CD) Myths
Reading time: 8 minutes
December 18th, 2023
For those looking for a low risk way to grow money, a certificate of deposit (CD) can be a great choice. A CD is a type of bank account that requires you to keep your money in the account for a fixed period of time, such as six months, one year, or five years. In exchange, the bank or credit union issuing the CD pays you interest. Because your money must remain in the account for the entirety of the CD term (early withdrawals normally incur lost interest or penalty fees), CDs usually offer higher interest rates than normal savings or checking accounts.
A regular savings account allows you the flexibility to make withdrawals. However, if you don't need access to your funds immediately and can leave your money alone for a set amount of time, a CD (with its higher interest rates) may be more attractive. There's a lot that CDs can offer as an investment.
However, because a CD isn't a regular savings account, there can be misconceptions about how CDs work and what they can provide. In this article, we'll debunk some of the most common myths about CDs.
Myth: CDs are only for large investments and the wealthy.
Reality: Anyone can invest in CDs. Many banks offer CDs that can be opened with as little as $500. Although larger deposits are likely to see a greater increase in funds over the course of the CD term (due to how interest accrues over time), any amount of money will generate growth.
Myth: CDs are risky.
Reality: Unlike the stock market, CDs do not fluctuate in value; as long as you leave the CD untouched for the duration of the term you opened it with, you will earn the full annual percentage yield (APY) of interest once the term of your CD is up. Additionally, CDs from an FDIC-insured bank or NCUA-insured credit union are guaranteed up to $250,000, in the unlikely event of the organization closing unexpectedly.
Myth: CDs are only for older account holders.
Reality: CDs can be a good investment opportunity for people of all ages, including seniors. Although CDs have traditionally been viewed as ideal for conservative investors and retirees, they allow anyone to build their savings in a safe and reliable way.
For example, there are no-charge CDs that don't charge penalties for early withdrawals before the maturity term, ideal for those looking to invest who also may need fee-free access to their funds. Or bump-up CDs that allow you to increase your APY when interest rates rise, perfect for investors hoping to capitalize on market changes. Whichever stage of life you're in and however you're strategizing your investments, there are many different types of CDs that may be appropriate for you.
Myth: In a CD, you cannot access your money.
Reality: Although CDs are designed for your funds to be set aside until the maturity date, it is possible to withdraw money from your CD before the term ends, if necessary. There may be an early withdrawal penalty or forfeiture of partial interest, but these fees are normally not extremely high.
Generally, CDs with a term of less than three months may receive a penalty of one month's worth of interest, while CDs with a term of three to 12 months may receive a penalty of three months' worth of interest. A CD with a one- to two-year term may receive a penalty of six months' worth of interest, and CDs that run longer than two years may receive a penalty of one year's worth of interest. (The minimum penalty amount is often $25.)
If you think you might need access to funds sooner than later, it's prudent to consider a CD with a shorter length of time, such as a six-month or even three-month term. Some banks offer no-penalty CDs to help investors avoid any early withdrawal fees altogether. You can also ladder multiple CDswith different length terms to ensure that your funds are regularly accessible as CDs reach maturity at various times throughout the year.
Myth: CDs are only for long-term saving.
Reality: CDs come in a variety of different term lengths. Some of the most common terms are three months, six months, one year, two years, three years, and five years. Although longer-term CDs sometimes offer higher interest rates for investors, there are many short-term CD options available for those who prefer access to liquidity or who don't want to commit their money for longer periods of time.
Myth: Interest rates are always fixed over the term length of a CD.
Reality: Though traditional CDs have fixed interest rates, there are variable-rate CDs that have changing interest rates based on market changes. These may be beneficial during periods of high interest rates (which means an increase in the interest you earn); this may also mean that your CD rate decreases when interest rates are low. It's important to understand the terms of your CD before investing by consulting a trusted financial advisor.)
Myth: You must pay taxes on any interest earned from a CD when you withdraw the money.
Reality: Many investors worry about a potential balloon of their taxable income when they withdraw from their CD at the end of the term. However, unlike capital gains from selling stock, interest earned from a CD is taxable in the year it is earned, not when it is withdrawn — which means your tax liabilities will be spread over the course of the years the CD is open. Additionally, you won't have to calculate this yourself; banks and credit unions automatically will issue you a 1099-INT form for your taxes if you have earnings to report.
Certificates of deposit, like any other type of investment, depend on your personal needs. If you have to access your funds on a regular basis, a traditional savings or checking account may be more suited for your needs. However, if you're looking for a stable and low-risk investment that can grow your money even during times of financial uncertainty, CDs may be an ideal choice. And with current interest rates, it's easier than ever to strategically incorporate CDs into your financial plan for the future.
Learn more about how you can reach your goals with a certificate of deposit.
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