Introduction to Certificates of Deposit
How CDs Work
A Certificate of Deposit (CD) is a low risk investment
vehicle offered through banks. CDs offer a fixed interest rate with
a promise to return both your principal and the interest it has
earned at a specific time and stated interest rate. The term, or
maturity, of most CDs ranges from six months to five years, though
CD investments can last longer or shorter.
Choosing a CD
are available through almost any bank. However, interest rates vary
from institution to institution. Since CDs are a very safe
investment and since maturities are similar from bank to bank, the
most important factor you must evaluate in choosing a CD is the
interest rate offered by the lending institution.
Generally speaking, the longer the maturity of the CD, the higher
the interest rate. You may choose to shop locally, calling local or
regional banks for their current rates, or you may contact a stock
broker to get quotes from across the country. Of course, the broker
may charge a fee for placing the investment, but may also be able to
identify higher interest rates on such investments.
Taxation of CD Interest
Interest earned on Certificates of Deposit if fully
taxable. It is reported on form 1040 as interest income in the year
it is earned, not necessarily distributed. This means that if you
purchase a three year CD, you will pay interest each year on the
interest being earned in the account, even though you will not have
access to the investment or interest until the three years are up.
Advantages of CDs
- You can base your CD maturity on your specific investment
- The interest rate is higher than on many accounts of similar
- The interest rate if fixed, allowing you to plan precisely
your investment payout
- When purchased directly from a bank, you pay no fee
- If interest rates go down, your CD rate stays higher
- Your investment is insured by the FDIC up to $250,000
Disadvantages of CDs
- Your rate could be changed if your bank is bought by another
- Early withdrawal penalties exist if you do not hold your CD to
- Your investment is not "liquid" if interest rates increase, your CD rate stays lower
CDs in Your Portfolio
A strong argument could be made for
CDs in your portfolio if you are looking for a safe, federally
insured, fixed interest rate investment with a known maturity date.
Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice.