What a CD Trades
A certificate of deposit exchanges liquidity for yield. You agree not to touch the money for a set term; the bank pays more than it would on a savings account and cannot cut the rate partway through. Both halves of that bargain matter: the rate is locked in your favour if rates fall, and locked against you if they rise.
APY Already Includes Compounding
CD rates are quoted as annual percentage yield, which folds compounding in. A 4.5% APY returns 4.5% over a year whether interest is credited daily or annually. Comparing two CDs by APY is therefore a fair comparison; comparing by nominal rate is not.
CD Rate Chart
Maturity value of a $10,000 deposit, monthly compounding:
| Term | 3.5% | 4.0% | 4.5% | 5.0% | 5.5% |
|---|---|---|---|---|---|
| 1 year | $10,356 | $10,407 | $10,459 | $10,512 | $10,564 |
| 2 years | $10,724 | $10,831 | $10,940 | $11,049 | $11,160 |
| 3 years | $11,105 | $11,273 | $11,442 | $11,615 | $11,789 |
| 5 years | $11,909 | $12,210 | $12,518 | $12,834 | $13,157 |
| 10 years | $14,183 | $14,908 | $15,670 | $16,470 | $17,311 |
The Early Withdrawal Penalty
Breaking a CD costs a set number of months of interest — typically 3 months on a 1-year CD, 6 months on a 3-to-5-year CD, and up to 12 months on longer terms. The penalty applies to interest, not principal, but if you withdraw very early the bank can take it from principal, leaving less than you deposited.
This makes the penalty a useful decision tool rather than only a risk. If rates rise 1.5% and you are two years into a five-year CD, breaking it and reinvesting can pay for the penalty within a year.
Laddering
A CD ladder splits the money across staggered maturities — one-fifth into each of 1, 2, 3, 4 and 5-year CDs. Each year one matures and is rolled into a new 5-year CD. After the fifth year you hold only 5-year CDs, which pay the highest rates, while a fifth of the money remains accessible every year. It is the standard answer to the liquidity-versus-yield problem.
Tax and the Real Return
CD interest is taxed as ordinary income in the year it is credited, even on a multi-year CD you have not touched. At 4.5% with a 22% tax rate and 2.5% inflation, the real after-tax return is about 1.1% a year. Positive, but the headline number and the useful number are far apart.
Frequently Asked Questions
Are CDs FDIC insured?
Yes, up to $250,000 per depositor, per bank, per ownership category, exactly like a savings account. Brokered CDs are also covered, but read who the issuing bank is — the coverage follows the bank, not the broker.
What is a no-penalty CD?
A CD that allows withdrawal after an initial period, usually seven days, without charge. It pays roughly 0.3–0.7% less than a standard CD of the same term, which is the cost of the option.
Should I choose a long or short CD?
Longer terms pay more when the yield curve is normal and less when it is inverted, which has been the case in several recent periods. Compare the actual quoted rates rather than assuming longer means higher.