Most banks offer certificates of deposits (CD) as savings vehicles for customers to deposit their extra cash for a fixed period of time. CDs enable you to earn interest at a higher rate than what you can expect from conventional savings accounts. Unlike stocks, bonds and mutual funds, CDs are insured by the United States Federal Deposit Insurance Corporation (FDIC) up to $250,000 in total deposit per depositor in each insured bank.
Early Withdrawal
A CD comes with a pre-defined term that typically ranges from three months to several years. Redeeming your CD before it matures may incur a penalty determined by the bank. The penalty may involve forfeiting several months worth of interest you have earned. If you cash in soon after the CD has been opened, you may not have earned enough interest to cover the penalty and you may even lose a portion of the principal. To avoid early withdrawal penalty, open a CD only if you can afford to have the money be locked for the duration of the CD.
Call Feature
Some long-term CDs have call features that give the issuing bank the right to terminate or call the CDs before they mature. A bank may decide to call its high-yield CDs if the interest rate in the financial market drops. After the CD is called, you can expect to receive the full amount of your principal plus any unpaid interest earned. CDs with call features tend to pay higher interest as compensation to investors for the potential risk of premature termination.
Disclosure
When you open a CD, you should be given a disclosure document that describes the features of your CD, including the annual percentage yield (APY) and whether the interest rate is fixed or variable. The document should also state how often you will receive interest payments, such as monthly or annually, and how you will be paid, such as electronic transfer of funds into your bank account.
Tax Reporting
Similar to other forms of income, interest income from CDs is taxable and must be reported to the Internal Revenue Services. The bank that issues your CD is responsible for sending you a 1099-INT form that states the amount of interest you received during the previous calendar year. Form 1099-INT should also state any penalty you may have incurred for early withdrawal. This amount can be subtracted from your taxable interest income on your tax return.
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