How Do CDs Work? Certificate of Deposit Explained (2026)

When you open a CD, you deposit a fixed amount of money — known as the principal — with a bank or credit union for a predetermined term. In return, the institution pays you a fixed APY for the duration of that term. Your interest rate is locked in at the time you open the account, which means it will not change even if market rates rise or fall during your term. At maturity, you receive your original principal plus any accumulated interest.

CD terms typically range from three months on the short end to five years or longer for jumbo or specialty products. Longer terms generally offer higher rates because you are committing your funds for a longer period. Rates also vary by institution, so comparing APYs across banks before opening an account is a prudent step.

CDs held at FDIC-member banks are insured up to $250,000 per depositor, per ownership category, per insured bank. This means your CD principal and accrued interest are protected up to that limit if the bank fails. Credit union CDs are similarly protected by the National Credit Union Administration (NCUA) up to $250,000 per depositor. FDIC insurance applies automatically — you do not need to apply or pay for coverage.

If you have more than $250,000 to deposit, you may be able to maintain full insurance coverage by spreading funds across multiple FDIC-insured institutions or by using different ownership categories (such as individual and joint accounts) at the same bank. The FDIC's Electronic Deposit Insurance Estimator (EDIE) tool can help you calculate your coverage.

CD interest rates are influenced by the federal funds rate target set by the Federal Reserve's Federal Open Market Committee (FOMC). When the Fed raises its benchmark rate, CD rates at banks tend to rise as well, though individual institutions set their own rates and the relationship is not always immediate or uniform. When you open a CD, your rate is fixed for the entire term regardless of what happens to market rates afterward.

Interest on a CD is typically compounded — either daily, monthly, or annually — depending on the institution's terms. More frequent compounding means your interest earns interest sooner, which may modestly increase your effective yield. The APY figure already accounts for compounding, making it the most useful number for comparing products across institutions.

One of the most important features of a CD is the early withdrawal penalty (EWP) that applies if you access your funds before the maturity date. Early withdrawal penalties are set by each institution and typically range from 90 days of interest for short-term CDs to six months or more of interest for longer-term products. In some cases, if you withdraw very early in a long-term CD, the penalty could reduce your principal.

Some banks offer "no-penalty" CDs that allow early withdrawal without a fee, though these products typically offer lower rates than standard CDs. Reading the full account disclosure before opening a CD is important so you understand the exact penalty structure. If you anticipate needing access to your funds before maturity, a high-yield savings account or a no-penalty CD may be more appropriate than a standard CD.

A CD ladder is a strategy where you divide your savings across multiple CDs with staggered maturity dates — for example, opening separate CDs with one-year, two-year, and three-year terms. As each CD matures, you can either withdraw the funds or reinvest in a new longer-term CD. This approach provides periodic access to your money while still capturing the higher rates typically available on longer-term products.

CD laddering can also reduce your exposure to interest rate risk. Rather than locking all of your savings into one long-term rate, you have portions maturing at regular intervals, which gives you the opportunity to reinvest at prevailing rates. This strategy is widely used by conservative savers who want predictable, insured returns with regular liquidity points.

Interest earned on a CD is generally taxable as ordinary income in the year it is credited to your account, even if you do not withdraw it. For CDs that compound and credit interest annually or more frequently, this means you may owe tax on interest before the CD matures. Your bank or credit union will typically send you a Form 1099-INT at the end of the year reporting the interest you earned.

CDs held inside an individual retirement account (IRA) may receive different tax treatment. Contributions to a traditional IRA are often tax-deductible, and interest grows tax-deferred until withdrawal. Roth IRA CDs may grow tax-free if you meet qualified distribution requirements. Consult a qualified tax professional for advice specific to your situation.