That's correct. A brokered CD is not a lot different than a bond. It will lose value if interest rates increase but if held to maturity, you will receive the face value.
At the end of that term, which can range from one month to several years, you can either cash out the CD or roll it over into a new CD with market terms. If you need to cash out before maturity, you may have to pay an early withdrawal penalty, typically a few months' interest.
Potential risks with brokered CDs
Market risk: The most common risk is that you'll need your funds before the CD matures. Although there are no early redemption fees (like there are for bank-issued CDs), you may receive less than your original purchase price.
Brokered CDs generally do not have early withdrawal penalties like CDs purchased directly from a bank. You can generally sell brokered CDs at any time in a secondary market, subject to market conditions.
Cons. Brokered CDs come with certain risks. For example, when interest rates are rising, you might lose money on a brokered CD if you sell it before the maturity date.
Brokered CDs:
Similar to bonds. Simple interest paid directly to Vanguard money market fund. Traded in a secondary market. Receive all accrued interest if sold prior to maturity.
Because brokered deposits do not require collateral, banks chasing fast growth used brokered funding to leverage their capital. In several cases, this quick pace of growth ended up resulting in poor credit decisions.
Yield to worst is the worst yield you may experience assuming the issuer does not default. It is the lower of yield to call and yield to maturity. It is possible that 2 bonds having the same face value and the same yield to maturity nevertheless offer different interest payments.
A callable CD gives the bank or brokerage firm that offers it the ability to “call” (or “redeem”) the CD earlier than its maturity date. The bank is more likely to take the CD back early if interest rates suddenly drop; in turn, the CD is less likely to be called if interest rates go up.
Letting it rollover to a CD with a lower rate
"One common mistake savers make when their CD matures is automatically letting it renew without checking if it's the best option," says Taylor Kovar, CFP and founder at 11 Financial.
Unlike gains on stocks or bonds that have gained value, which are subject to capital gains taxes, certificates of deposits are not considered investment securities and gains are reported to the IRS on form 1099-INT as regular income. Federal Deposit Insurance Corporation. "Deposit Insurance FAQs."
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.
However, the main differences are that Brokered CDs are offered by issuing banks, and they can be purchased through multiple brokers. And unlike a bank CD, a brokered CD can also be traded on the secondary market. The secondary market is where trades in securities outside of their initial distribution occur.
Interest rate fluctuation
Like all fixed income securities, CD valuations and secondary market prices are susceptible to fluctuations in interest rates. If interest rates rise, the market price of outstanding CDs will generally decline, creating a potential loss should you decide to sell them in the secondary market.
Brokered CDs' values can change based on the interest rate environment. So if your brokered CD has decreased in value when you go to sell it, you will lose money.
Brokered CDs generally command a higher yield than bank CDs, as they are in a more competitive market. The broker has invested a large sum with the bank, and that generates more interest than smaller amounts. As with all CDs, holders receive the full principal with interest at maturity.
And brokered CDs are like bonds in that when they're being traded, their value can change based on the interest-rate environment — so you could lose money. Plus, some brokerages tack on a trading fee when you sell CDs. (For more access to funds, see the best high-interest savings accounts.)
CDs offered through Raymond James offer a Survivor's Option, which allows the estate, upon the death of the holder(s), to redeem CDs from the issuer at par plus accrued interest. Irrevocable trusts do not offer a survivor's option.
Custodial deposits held in the name of a broker on behalf of their investors and deposited in an FDIC insured financial institution are covered by federal deposit insurance, the same as if the funds had been deposited directly by the broker's clients in the same institution.
The SIPC covers shortfalls in customer accounts up to $500,000, including $250,000 in cash. This coverage only occurs when customer securities are missing when the brokerage firm fails. In addition, most large brokerage firms maintain supplemental insurance for much more than the $500,000 insured by the SIPC.
Deposit brokers provide intermediary services for banks and investors. This activity is considered higher risk because each deposit broker operates under its own guidelines for obtaining deposits.
Your money may not be protected: The money you invest in a brokered CD is protected only if it's provided by a bank insured by the Federal Deposit Insurance Corporation or a credit union insured by the National Credit Union Administration. If it's not, you could lose all your funds if the financial institution fails.
The interest is taxable, the IRS says, in the year it is paid. If you've earned more than $10 in interest in a year, the bank or credit union that issued the CD will typically send you a Form 1099-INT statement. Box 1 shows how much interest you earned that year from the CD.
Key Takeaways
CD owners can name one or more beneficiaries to inherit CD accounts after they pass away. Interest earned on CDs prior to the owner's death is not taxable to the person inheriting it, but interest earned after their death is taxable.