Pros of CDs Explained
Safety and security: You can save money in a CD without worrying about a stock market plunge or other risks. CDs come with fixed interest rates and FDIC or NCUA insurance, which could protect your money even if your bank fails.
CDs and savings accounts are two types of deposit accounts that earn interest. CDs park your money for a set period. They pay higher rates but come with penalties for early withdrawals. Savings accounts usually earn less but allow withdrawals when you want.
CDs are one option that can help protect your investment from times of turmoil by providing stable income. The returns gained from these investments usually won't be as high as those provided by stocks but they can serve as a cushion to balance your portfolio and keep it afloat when the market is down in the dumps.
One of the primary disadvantages of CDs is the lack of liquidity compared to other types of investments. When you invest in a CD, your funds are typically locked in for a specific term, ranging from a few months to several years.
If you put $500 in a CD for five years, how much would you make? This depends on the CD rate. A five-year CD at a competitive online bank could have a rate of 4.00% APY, which would earn around $108 in interest in five years. A five-year CD with a 1% rate would earn about $26.
Interest earned on CDs is considered taxable income by the IRS , regardless of whether the money is received in cash or reinvested. Interest earned on CDs with terms longer than one year must be reported and taxed every year, even if the CD cannot be cashed in until maturity.
You shouldn't put yours into a CD. Depending on APYs, storing your emergency fund in a CD may earn you more interest than a savings account. You'll face an early withdrawal penalty if you need to pull out your money before the CD matures. It could also take several days to receive your funds.
Federal law sets a minimum penalty on early withdrawals from CDs, but there is no maximum penalty. If you withdraw money within the first six days after deposit, the penalty is at least seven days' simple interest. Review your account agreement for policies specific to your bank and your account.
How much interest would you earn? If you put $20,000 into a 5-year CD with an interest rate of 4.60%, you'd end the 5-year CD term with $5,043.12 in interest, for a total balance of $25,043.12. Not all CDs offer that interest rate, though.
By depositing $10,000 into a CD now, you can take advantage of currently high rates, protect yourself against future rate cuts and enjoy significant returns on a low-risk investment. Plus, you'll have the added benefit of security, knowing that your principal is safe and your returns are guaranteed.
CDs insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000 cannot lose money even if the bank fails. However, some CDs that are not FDIC-insured may carry greater risk, and risks may come from rising inflation or interest rates.
An early withdrawal penalty is a fee that banks charge if you take money out of a CD before it matures. The penalty is meant to discourage early access to the funds since CDs offer higher interest rates in exchange for locking in your money for a fixed period.
CDs offer a fixed interest rate over a specified term, and are typically insured up to $250,000, making them low-risk. Treasury bills are short-term government securities backed by the U.S. government, making them one of the safest investments available.
One major drawback of a CD is that account holders can't easily access their money if an unanticipated need arises. They typically have to pay a penalty for early withdrawals, which can eat up interest and can even result in the loss of principal.
As Beene notes, "The recent rate cuts by the Fed have already produced small drops in the rates of CD and savings accounts at many major banks, and we're going to see that continue if interest rates drop. If you want to lock in a certain rate a CD currently provides, it would be a good idea not to wait."
Simply put, yes, the IRS will tax all interest earned on your CD as ordinary income unless the CD is held in a tax-advantaged retirement account. 1 This will be due for each tax year in which the interest is earned.
Roth Individual Retirement Account (IRA) or Roth 401(k): Interest earned in a Roth account is not taxed until it is withdrawn. And, if you are older than age 59 ½, you will owe no income taxes at all on the interest. However, early withdrawals before age 59 ½ incur a 10% penalty in addition to any income tax due.
That said, here's how much you could expect to make by depositing $20,000 into a one-year CD now, broken down by four readily available interest rates (interest compounding annually): At 6.00%: $1,200 (for a total of $21,200 after one year) At 5.75%: $1,150 (for a total of $21,150 after one year)
While longer-term CDs may tie up your funds for years, a 6-month CD allows you to access your money relatively quickly. If you suddenly need your $5,000 for an emergency or a more lucrative investment opportunity arises, you won't have to wait years to access your funds without incurring hefty penalties.
Like IRAs and 529 plans, there are a variety of investments you can buy within an HSA, and your options depend on the financial institution that holds your account. If you invest in CDs within your HSA, you can avoid paying taxes on the interest, provided you use distributions to pay for qualifying expenses.