Certificates of Deposit vs. Savings Accounts

These interest-earning accounts have important distinctions

It's generally considered wise to set some money aside for the future when possible. While stuffing cash under your mattress may seem like the easiest solution for some, your local bank or credit union offers better options like a traditional savings account or a certificate of deposit (CD) for a more secure way of holding onto your funds. While both accrue interest and include some inherent benefits, there's enough difference between them that you should know which best suits your needs.

Key Takeaways

  • Though CDs and savings accounts accrue interest, the former option typically offers higher rates.
  • Funds are more accessible at any time with a savings account, while CDs are best left alone for a set amount of time.
  • In both instances, the bank is effectively borrowing money from you, so it pays you interest over time.
  • Both options are federally insured by the FDIC or NCUSIF.

What Is a Certificate of Deposit (CD)?

Typically offered at almost all banks and credit unions, a certificate of deposit (CD) is a type of deposit account that offers a higher than normal interest rate as long as the customer agrees to leave a lump sum of money alone for a set amount of time. Early withdrawal is possible with a CD, though there will be penalties for not waiting until the end of its term to receive your funds. How long that money must remain untouched before the CD matures can vary from just a couple of months to several years, with longer terms yielding more earnings through interest.

Benefits of opening a CD

  • Great interest rates: Since the main conceit of a CD is to leave your money untouched for a set amount of time, financial institutions offer higher interest rates than they would for a savings account. Typically, financial institutions have been known to offer interest rates that are up to six times higher than the national average.
  • Interest is locked in: While most banking products that offer interest usually do so at a variable rate, CDs come with a fixed interest rate attached to them. Not only does this mean your deposit will be protected from wild market swings should they occur, but it also means you'll be able to calculate exactly how much your expected return will be once the CD matures.
  • Excellent for planning ahead: Since you'll know exactly how much money you'll receive once the CD has matured, you'll be able to more accurately plan ahead. Having that information on hand means you can better prepare for an upcoming trip or save for a down payment on a new home.
  • 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 opening 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 exist for early withdrawal: The entire point of a CD is to keep the money you set aside in the account for a predetermined amount of time. To dissuade people from withdrawing from their CDs before they reach maturity, banks are required by law to impose an early withdrawal penalty. How much that fee will be and how it's calculated will be outlined in the account agreement.
  • Negatively impacted by inflation: Inflation fears have grown in recent months, as the pandemic continues to wane and the economy recovers. If the inflation rate is higher than a CD's interest rate, you may end up losing money.
  • Can't usually add funds once opened: Unlike other deposit accounts, you can't add to its balance. However much your initial deposit is at the account's creation is final until it matures.

What Is a Savings Account?

Like CDs, a savings account is a deposit account that accrues interest over time. Offered at virtually every bank and credit union in the country, savings accounts offer very modest interest rates compared to other account types. Though the money kept in a savings account can be accessed at any time, there are limitations on how many withdrawals you can make before either potentially getting hit with fees, getting the account changed to a checking account, or the savings account being closed by the bank.

Benefits of a savings account

  • More accessible funds: Unlike CDs, the money you deposit into a savings account can be accessed at any time. How much you can withdraw is limited by the account's balance. You are limited, however, in how many withdrawals or transfers you can make in a given month.
  • Can deposit more money whenever you want: You can deposit more money into your savings account whenever you want. This allows you to set aside money for any short- or medium-term goals you have in mind. As you add more money to your account, you will accrue more in interest over time.
  • Engenders good saving habits: Savings accounts make it easy to track your deposits and withdrawals, whether you choose to do so online or with an old-fashioned checkbook. You can also establish an automatic savings plan so a portion of your paycheck goes directly into your savings.

Savings account drawbacks

  • Low interest rates: While savings accounts can earn an interest rate, most don't come with a high yield. The average savings account pays approximately 0.07% in interest, so don't expect a huge payout over a short period of time. High-yield savings accounts do exist, however,
  • Limitations exist at the federal level: There's no limit to how much you can withdraw in a single transaction, but federal law used to limit how many withdrawals or transfers you can make in a set amount of time. In April 2020, the Federal Reserve paused the six-withdrawals-per-month limit, although individual institutions may continue to restrict withdrawals.
  • Interest rates fluctuate: While it's easy to have interest compound upon itself in a savings account, it's important to note that banks can adjust savings account interest rates when deemed necessary. 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 open. This fee can cut into your interest earnings over time.

How Can I Open a High-Yield Savings Account?

First, check to see if your current bank offers competitive high-yield savings accounts. If so, it should be quite easy to open a new account. You may even be able to do it online because you are already verified by that provider. If you're opening a savings account at an institution you haven't worked with before, it might have a few more steps but it will still be fairly straightforward. You'll likely need your driver's license, Social Security number, and primary bank account information at hand to facilitate 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 often rise in lockstep. Interest rates paid for deposit products like CDs often lag for many 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 have been very low for many years due to low interest rates set by the Federal Reserve. However, interest rates on deposit products will likely rise in the near future due to the Federal Reserve's monetary policy to combat inflation.

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, then 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 without the risk of any penalties, then a CD could be a wise choice.

Article Sources
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  1. Consumer Financial Protection Bureau. "What Is a Certificate of Deposit (CD)?"

  2. Code of Federal Regulations. "12 CFR 1030: Truth in Savings Act (Regulation DD)."

  3. Federal Deposit Insurance Corporation. "National Rates and Rate Caps."

  4. Federal Reserve Board. "Federal Reserve Board Announces Interim Final Rule to Delete the Six-per-Month Limit on Convenient Transfers From the "Savings Deposit" Definition in Regulation D."

  5. Federal Reserve Bank of St. Louis. "Federal Funds Effective Rate (FEDFUNDS)."