Everything you need to know about a certificate of deposit, or CD

If you've already maxed out your emergency fund or have met your other savings goals and want to try a safe way to earn a little more interest, consider a certificate of deposit, or CD.

Here's everything you need to know about a CD, from what it is to how to incorporate it in your financial plan.

What's a CD?

A CD is a conservative way to earn interest on the money you've saved. It's kind of like a savings account, except that:

1. It generally has a fixed maturity date or term.

In other words, you can only withdraw your money without penalty after a certain period, usually between a few months and several years.

2. Usually, the interest rates for CDs are higher than traditional savings accounts.

Interest rates usually depend on the length of the term and, in some cases, on the amount of your deposit, like a jumbo CD. Long-term CDs generally have higher interest rates than short-term CDs.

When your CD matures, or the term ends, you receive your deposited money plus the interest you earned along the way. You can always decide to renew the CD for the same or a different term.

When your money is in a bank CD, it's as safe as it is in a savings account. Bank CDs are generally insured up to Federal Deposit Insurance Corporation, or FDIC, limits.

Are CDs right for you?

Whether a CD is the right financial choice for you depends on when you'll need your money and how high interest rates and inflation rates are.

Why does it matter when you may need your money? Because CDs typically have early withdrawal fees for taking your money out before the CD matures. Those penalties could wipe out any potential earnings from interest and, in some cases, eat into your deposit amount itself.

If you're planning for a significant purchase in a few years and you want your money to earn more than what your savings account is providing, then a CD may make sense for you. Let's say you want to buy a house in five years and you've saved $7,000 for your down payment. You don't want to risk putting it into the stock market, but you also want to earn a bit more than what you're getting from your savings account.

CDs give you safety of principal. In other words, the value won't go down if you leave the funds in the CD for the full term.

The financial climate also impacts whether CDs are a wise choice. If inflation rates are higher than the interest rate you're locking in with your CD, then you may want to think twice about putting your money in a CD for a specified time.

If interest rates rise during the term of your CD, you may not be able to take advantage of that if your rate has already been fixed. Some CDs offer variable rates, which could help when rates are rising.

Banks report how much money a CD will earn in terms of annual percentage yield, or APY. The APY indicates the rate of interest you'll be earning including compound interest during the term. Compound interest is interest earned on your original amount, or principal, plus interest earned on top of the interest that has been reinvested in the same CD.

An APY varies with the term of the CD. Shorter-term CDs will typically have a lower APY. The APY assumes the interest remains in the CD for the full length of the CD term.

You can lessen the risk of locking your money into a CD at a lower rate through a strategy that requires you to own more than one CD at a time.

Having a CD ladder means that you spread your funds over a number of CDs with varying maturity dates. The staggered maturity date hopefully enables you to get the highest rate offered every time your accounts mature.

If interest rates go up, you'll have cash from the maturing CD to open new CDs, and if rates go down, you'll still have the other CDs growing at a higher interest-rate. A CD ladder also gives you periodic access to some of your funds, which can help you avoid early withdrawal penalties.

Which CD is right for you?

CDs come in many forms, including traditional and more specialized accounts with varying conditions.

• Standard CDs have a fixed interest rate and APY for the term of the CD.
• Variable-rate CDs have fixed terms but fluctuating interest rates. The rate could be tied to the prime rate index, consumer price index, treasury bill rate or some other methodology as determined by the bank.
• Jumbo CDs can only be opened with an elephant-size wad of cash. The interest rates on these accounts can be slightly higher than a traditional CD.
• There are also various types of adjustable-rate CDs where the bank can reset the rate at specific times or you have the option to request a change in the rate.

Generally speaking, the more flexibility a CD gives you, the lower the APY you'll receive. Be careful to check that the CD you're applying for is from an FDIC-insured institution.

Using CDs as part of your retirement plan

Some CDs are tied to retirement accounts. An IRA CD can be a low-risk piece of your retirement portfolio. If you choose this option, don't forget that you won't be able to access the money in an IRA until you're 59½ years old without paying any taxes due and possibly a penalty, if you don't have a qualifying exception. Like other CDs, IRA CDs have guaranteed, but not high, returns.

When you're looking at longer-term investments, you have more growth opportunity in the market. But the market also brings loss of principal risk.

The bottom line is, a CD can be a great choice to provide a low risk return that is great than what you might earn through a savings account.

The USAA Advice Center provides general advice, tools and resources to guide your journey. Content may mention products, features or services that USAA Federal Savings Bank does not offer. The information contained is provided for informational purposes only and is not intended to represent any endorsement, expressed or implied, by USAA or any affiliates. All information provided is subject to change without notice.