Certificates of deposit (CDs) are locked savings plans set up by banks or credit unions that promise a certain percentage of interest over time. Generally, the money is expected to remain in the account untouched, but in an effort to attract more savers, banks offer flexible alternatives for a variety of CDs.

 

Consumers can choose from a number of CD products, based on:

 

• the terms of the deposit (the length of time the money stays in the account, usually three months up to five years),

• the minimum deposit amount,

• the interest rate, or annual percentage yield (APY)

• the liquidity of the money (the ability to withdraw money before the term matures),

• the penalty, if any, for withdrawal, or

• the penalty, if any, if the account falls below the minimum deposit.

 

CDs are a slower way to make your money earn more money, when compared to investing in the stock market. However, CDs are a relatively risk-free investment option, especially during difficult economic times.

 

Benefits of CDs

 

The benefits of CDs include:

 

• Federal Deposit Insurance Corporation (FDIC)-insured

• Daily compounded interest

• Monthly or quarterly interest checks are mailed or electronically transferred

• Ability to add additional funds during the term

• Some CDs offer automatic renewal at maturity

 

Traditional CDs

 

With a traditional CD, customers can deposit a fixed amount of money for a fixed amount of time at a fixed interest rate. When the term matures, you can withdraw the money. Interest rates are lower when terms are short and higher when terms are longer. Traditional CDs incur penalties for early withdrawal, and banks may charge other fees, provided the fee policy is disclosed to the customer at the time the account is opened.

 

Bump-Up CDs

 

With bump-up CDs, the consumer benefits if interest rates go up. If the bank is offering a higher interest rate six months after the customer opened the CD, the customer can now have the CD at the higher rate. The disadvantage is that banks that offer bump-up CDs will offer a low initial interest rate in the anticipation of rates going up. Moreover, a bump-up account is limited to only one increase in the interest rate during the length of the term.

 

Callable CDs

 

With callable CDs, the consumer takes on more risk if interest rates go down. The bank will give the customer the benefit of an additional quarter or half percent of interest in return for the right to call back the deposit and reissue the CD if interest rates go down. The customer is protected by an initial call-protection period, such as the first six months, during which the interest rate remains fixed. However, if interest rates go down after the call-protection period, but before the CD matures, the CD will be reissued at the lower rate. The customer does retain the full principle and interest gained during the call-protection period.

 

Liquid CDs

 

Liquid CDs allow consumers to withdraw money from the account, before the term matures without penalty. The consumer sacrifices a higher interest rate for the privilege of liquidity. Liquid CDs require a minimum amount of money to remain in the CD and limit the number of withdrawals allowed. The bank determines how soon after opening the account the customer may begin withdrawing money.

 

High-Yield CDs

 

To compete, banks will offer individual consumers a higher than average rate for a CD with a high principal deposit, such as $5,000 minimum, for a 12-month term. High-yield CDs usually come with a limit to the total amount a customer can invest and have penalties for early withdrawal. Shop online for banks offering high-yield CDs.

 

Jumbo CDs

 

For minimum deposits of $100,000, these liquid CDs offer a high interest rate compared to traditional CDs. Terms tend to be short – two weeks to one year – and the customer is able to negotiate the interest rate with the bank. The disadvantage with jumbo CDs is that the FDIC generally insures deposits only up to $100,000 (with some exceptions). Jumbo CDs are often used by larger organizations, such as pension funds and corporations, rather than by individuals.

 

Zero-Coupon CDs

 

For long-term, high deposits of $50,000 to $100,000, zero-coupon CDs allow the customer to buy a high value CD with a high interest rate for half its initial investment (such as buying a $50,000 CD for a deposit of $25,000) in return for zero interest payments during the length of the term. This accrued – but not distributed – interest is invested. Customers should be aware that, while the account is earning interest, even though no interest payments are received, taxes still need to be paid on the earned interest. Zero-coupon CDs are for investors who have the money to pay taxes on money they are not yet able to pocket.

 

Many options exist for savvy consumers. Major financial institutions, such as Bank of America, ING Direct, E*Trade, Fidelity, and Capital One, offer their own CD products, so shop around.