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Certificates of Deposit (CDs) vs. Savings Accounts

While stuffing cash under a mattress may seem like the easiest solution, your local bank or credit union offers better and safer options. Either a traditional savings account or a certificate of deposit (CD) would earn some interest. At nearly all U.S. banks and credit unions, your money in either a CD or a savings account will be federally insured for losses up to $250,000.

There are still enough differences that you should consider which is best for you.

Key Takeaways

  • CDs usually offer higher rates of interest than savings accounts. Savings accounts offer some of the lowest rates of any investment.
  • A savings account keeps your money accessible. A CD commits you to leaving the money in the bank for a set term.
  • Both options are federally insured against losses.

What Is a Certificate of Deposit (CD)?

Offered by almost all U.S. banks and credit unions, a certificate of deposit (CD) is a financial product that pays the investor a set rate of interest in return for leaving a sum of money in the bank for a set period of time.

It offers a higher interest rate than a savings account, as long as the customer leaves the money alone. Withdrawals before the maturity date are possible but there are penalties. These vary but can add up to a loss of your interest and even a bit of the principal deposit.

CDs can be purchased for terms as short as a month or as long as 10 years or more. Generally, the longer the term the higher the interest the CD pays.

Benefits of a CD

  • Better interest rates: Since the whole idea of a CD is to leave your money untouched for a set amount of time, banks offer higher interest rates than for a savings account. CD rates can be up to six times higher than the national average for savings accounts.
  • Interest is locked in: Almost all CDs come with a fixed interest rate. Your deposit will be protected from interest rate changes and you’ll be able to calculate exactly how much your expected return will be.
  • Good for planning ahead: Since the rate is set, you’ll be able to plan more accurately. If you’re saving for a down payment on a new home, you’ll know how much you’ll have.
  • No maintenance fees: Generally speaking, CDs do not come with monthly maintenance fees, meaning you’ll be able to take all of your interest earnings home with you.

Drawbacks of a CD

  • Need to wait for maturity: At its core, a CD requires more patience than a traditional savings account. Once you lock down your cash in a CD, it’s there for the term’s duration.
  • Penalties for early withdrawal: The entire point of a CD is to keep the money in the bank for a set period of time. Banks are required by law to impose an early withdrawal penalty. How much that fee will be and how it’s calculated is set by the bank and will be outlined in the account agreement.
  • Inflation will hurt CD returns: During the term of your CD, inflation may rise to a level higher than the interest rate you’re receiving. Your real return in terms of buying power will be reduced.
  • Can’t add money over time. CDs are purchased in lump sums. You can buy more CDs over time, but you can’t deposit more money in an existing CD.

What Is a Savings Account?

Like a CD, a savings account is a deposit that accrues interest over time. Savings accounts offer very modest interest rates compared to other account types and other investments.

You can get your money at any time, but even that has limits. Some banks impose fees for frequent withdrawals.

Benefits of a Savings Account

  • More accessible: Unlike CDs, the money you deposit into a savings account can be accessed at any time. You may be limited, however, in the number of withdrawals or transfers you can make in a given month without getting hit with fees.
  • Can deposit more money whenever you want: Savings accounts are good for people who have a specific financial goal, such as saving a certain amount out of every paycheck. It’s easy to transfer the amount from checking to savings, where you’ll be less tempted to spend it.
  • Supports good saving habits: Savings accounts make it easy to track your deposits and withdrawals, online or with an old-fashioned checkbook. You can establish an automatic savings plan so a portion of your paycheck goes directly into your savings.

Drawbacks of a Savings Account

  • Low interest rates: The interest rates offered for savings accounts are not high. As of August 2022, one of the “best” available rates cited was 2.10% and that came with a minimum $5,000 balance.
  • Possible limitations on withdrawals: There’s no limit to how much you can withdraw in a single transaction, but federal law can limit how many withdrawals or transfers can be made in a set amount of time. In April 2020, the Federal Reserve paused the six-withdrawals-per-month limit, although individual banks are free to restrict withdrawals.
  • Interest rates fluctuate: Banks can adjust savings account interest rates as market conditions change. That fluctuation can make it hard to determine exactly how much you will receive over a set amount of time.
  • Additional fees: Most banks will charge a monthly maintenance fee if you keep a savings account. This fee will cut into your earnings over time.

How Can I Open a High-Yield Savings Account?

First, check to see which banks are offering competitive high-yield savings accounts. Once you find one, the process is easy, online or in person.

It will be especially easy if you open the account online with a bank you already do business with. It has already verified your identity.

If you’re opening a savings account at an institution you haven’t worked with before, there might be a few more steps. You’ll need your driver’s license, Social Security number, and primary bank account information at hand for the application process.

How Are CD Interest Rates Determined?

Bank and credit unions set interest rates based on their need for deposits, their cost of funds, and competitive market forces.

When the prime rate is raised by the Federal Reserve, interest rates for credit products like credit cards usually rise in lockstep. Interest rates paid for deposit products like CDs often lag for months, though.

How Are Interest Rates Determined for Savings Accounts?

As with certificates of deposit, interest rates for savings accounts are set by banks and credit unions based on competitive pressures, their needs for deposit capital, and the cost of borrowing from the Federal Reserve.

Interest rates for savings accounts were very low for many years due to consistently low rates set by the Federal Reserve. However, in 2022 the Federal Reserve was steadily raising its key interest rates, and banks were following through with higher rates for their customers.

The Bottom Line

When it comes down to deciding whether you should open a CD or a savings account, it really depends on your intentions. If you want to set money aside but still want instant access to those funds in the event of an emergency, you’ll likely want to open a savings account. However, if you’re okay with waiting months or years before you can gain access to those funds, a CD would be a wiser choice.

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