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What is a Bank CD?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 04 November 2016
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    Conjecture Corporation
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The bank CD, or certificate of deposit, is a simple but useful means of creating financial security for the future. As a money market instrument, the rate of interest earned on a bank CD is based on current money market rates. Many people consider the bank certificate of deposit to be among the safest investment opportunities available today.

Setting up a bank CD involves depositing money into a special account with a banker. This deposit remains in the account until a pre-determined maturity date is reached. In return for leaving the money in the CD account until maturity is reached, the bank applies a specific or fixed rate of interest to the funds deposited. It is possible to set up a bank CD with a duration of anywhere between one year to five years.

In the event that the depositor chooses to withdraw funds from the CD account before the maturity date is reached, most banks will assess severe penalties. The penalties are often enough to offset any returns that would have been realized had the bank CD remained in place until maturity. This process serves to encourage investors to leave the bank CD in place unless an emergency situation arises.

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Once the maturity date is reached, investors have several options open to them. One option is to have the accrued interest transferred into a savings or checking account and renew the CD for another period of time. The second approach is to reinvest both the principal and the interest for another interest-bearing period. Finally, the investor may choose to receive both the principal and the accrued interest as cash or as a funds transfer into an existing account. It is important to keep in mind that taxes are usually due on any funds generated by the bank CD and possibly on the principal as well, if that balance was used as a deduction in years past.

Both banks and investors can benefit from creating a bank CD rather than simply depositing the funds into a standard savings account. Since there is a maturity period that allows the bank to make use of those funds for an extended period of time, bank CD rates are usually superior to the amount of interest that can be earned with a savings account. Banks receive a reasonable amount of assurance that the funds will remain in the possession of the bank for an extended period of time, whereas a depositor may withdraw funds from a savings account at any time.

For anyone who has a sum of money that will not be needed in the foreseeable future and who wants to earn a higher rate of interest, a bank CD is a much better option than a savings account. While not yielding returns that are comparable to bonds or stock options, bank CD rates provide a decent return with a much lower amount of risk. This makes the bank CD an attractive savings tool for people who are very conservative with their money.

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