By Harry Prabandham · Updated September 28, 2026
Personal Finance
Certificates of Deposit (CDs): How They Work, Penalties, and Ladders
A CD is a bank deposit paying a fixed rate for a set term, FDIC-insured up to $250,000 per depositor, bank, and ownership category.
Certificates of Deposit (CDs): How They Work, Penalties, and Ladders
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What is a certificate of deposit?
- A CD is a time deposit at a bank or credit union that pays a set interest rate for a fixed term, from months to several years.
- Bank CDs are FDIC-insured up to $250,000 per depositor, per insured bank, per ownership category; credit union CDs carry similar NCUA coverage.
- In exchange for the rate, you agree to leave the money in place until maturity or pay a penalty.
- CD interest is taxable federally and by your state, generally as it accrues, even on multi-year CDs that pay at maturity.
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Full Guide
What is a certificate of deposit?
- A CD is a time deposit at a bank or credit union that pays a set interest rate for a fixed term, from months to several years.
- Bank CDs are FDIC-insured up to $250,000 per depositor, per insured bank, per ownership category; credit union CDs carry similar NCUA coverage.
- In exchange for the rate, you agree to leave the money in place until maturity or pay a penalty.
- CD interest is taxable federally and by your state, generally as it accrues, even on multi-year CDs that pay at maturity.
How are CD rates set?
- Most CDs lock the rate at purchase, though some are variable-rate or step-up.
- New CD rates tend to follow short-term interest rates, which respond to Federal Reserve policy.
- Longer terms don't always pay more; when rate cuts are expected, longer CDs can pay the same or less.
- Callable CDs let the issuer redeem early, usually when rates fall, leaving you to reinvest at lower rates.
What happens if you withdraw early?
- Banks set their own penalties, often several months of interest, and must disclose them when you open the account.
- Federal rules require at least seven days' simple interest as a penalty on withdrawals within six days of deposit.
- A penalty can exceed the interest earned and reduce principal if you withdraw soon after opening.
- Early withdrawal penalties are deductible as an adjustment to income on Schedule 1 of Form 1040.
- No-penalty CDs allow early access, usually at a lower rate.
How does a CD ladder work?
- A ladder splits money across CDs with staggered maturities, such as one through five years.
- As each CD matures, the cash is available to spend or roll into a new CD at the longest rung.
- The structure provides regular access to part of the money and spreads rates across different points in time.
- The trade-off is that most of the money stays committed, and ladder yields lag when rates rise quickly.
How do brokered CDs differ from bank CDs?
- Brokered CDs are bought through a brokerage account; FDIC coverage passes through to you when the broker keeps proper records.
- They can be sold before maturity on a secondary market, but the price may be above or below what you paid.
- Many longer-term brokered CDs are callable, so read the terms before buying.
- Coverage limits apply per issuing bank, so deposits held at one bank through different channels count together.
How do CDs compare with savings accounts and Treasury bills?
- Savings accounts offer full liquidity, but their rates can change at any time.
- Treasury bills are backed by the U.S. government, and their interest is exempt from state and local income tax, unlike CD interest.
- CDs fit money set aside for a known period; money you might need any day fits a more liquid account.
Key takeaways
- A CD trades access to your money for a fixed rate over a set term.
- FDIC coverage is $250,000 per depositor, per bank, per ownership category.
- Read the early withdrawal penalty and any call feature before buying.
- In high-tax states, compare CD yields with Treasury bills on an after-state-tax basis.
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