Certificate of Deposit (or CD account)

A Certificates of Deposit account is kind of savings account. With a savings account, you can withdraw money at your will. However, with a CD account you agree with the bank to keep your money in the bank for a pre-determined term, short as a few months or long as one year or longer. For your promise to keep your money with the bank, your account earns a higher interest than a savings account. In general, the longer you promise to keep money in your account, the higher the interest rate your money will earn.

If you need your money before the CD matures, the bank will likely charge you an early withdrawal penalty when you make the withdrawal. The amount of penalty is discussed at the time account is opened. Typically, banks charge you a few months of interest when you make the withdrawal earlier than the term of the CD. Let’s work with an example to explain this.

Suppose you open a CD account with $1,000, with a two-year term. Assume your account earns $10 in interest every month. The penalty for early withdrawal is three months of interest. After 18 months into the life of the CD account, you decide to make a withdrawal. Under the early withdrawal terms, you will loose $30 from your account ($10 for each month for 3 months). Your account remained opened for 18 months and your account earned $180 in interest, leaving $1,180 in your CD account. Because of the early-withdrawal penalty, you will get only $1,150 (=1,180 – 30).

If the account was not closed early and remained opened for 24 months or the term of the CD account, the account balance at the end would be $1,240 ([$10 *24] +1000).

Beside the penalty provision, another thing to watch with CD accounts is the renewing of the CD. Basically, it means if you leave your money untouched for x number of days (usually 10 business days) after the CD account matures, the CD account will automatically renew for another term.

That is fine probably if you don’t have any other use for your money for the term of the new CD. But if you do want to get your money out of the CD account without paying penalties, do so during the time frame when the bank notifies of your CD account coming due. As mentioned earlier, the bank typically gives you 10 days to have you make changes to your existing CD account. The bank usually sends a notice 15 days (or earlier) prior to the CD coming due. The notice will contain your renewing and withdrawal options. If you don’t make any changes to the CD account, the bank will assume you want to renew your account thus your account will be rolled over automatically for another term.

If there is a fear of making long-term commitment with CD account terms, one option is to open multiple CD accounts with rotating maturity dates. Suppose a customer is deciding to deposit $2,000 into a CD account. Instead of opening 1 CD account for 1 year, here is an alternative:

Rotating CD maturities

In this example, the customer opens two main CD accounts with $1000 in each account. The first account is renewed after 3 months of opening, again 6 months after that, and lastly 3 months after that. In contrast, the second account renews only once, after six months of opening. In essence, what this scenario shows is rotating the maturity of one or more accounts every three months. Every three months at least one account is rolled over for three or six months. With this approach, the customer has multiple opportunities to withdrawal his money from his accounts in a year. This would not be the case if only one account was opened with $2000. The process of rotating the due date can be repeated as necessary in to the future years.

When opening a certificate of deposit account, consider all the factors with each varied CD offerings out there. Table 1 shows you the main three types of certificate of deposit options that may help you decide a CD account that is right for you.