Deposit Accounts: Types of CDs

by Amy Lillard

(2/26/2013) Certificates of Deposit (CDs) are a relatively simple way to put some money aside and watch it grow over time. If you decide to use a CD to amp up your savings, there are multiple options to choose from.

No matter what CD you choose, the concept is still the same. In each, you deposit a sum into the account for a specified amount of time, ranging from weeks to years. Over that time, you are guaranteed a specific amount of interest to grow your balance. CDs are safe and easy but shouldn't be used if you may need the money right away — there are usually hefty penalties for withdrawal before the maturity date.

From there, the different types of CDs offer varying details.

• Traditional. As described above, the traditional CD allows you to save a fixed amount for a specific term and receive fixed interest.

• Bump-up. CDs will offer a fixed interest rate over time, which is quite a benefit if rates fall. But if you have a 10-year CD and rates are rising, you're stuck. With a Bump-Up CD you have the option of asking for higher rates when they're available. Institutions will typically limit the bump-up requests you can make over the term. Plus, your initial rate may be lower than for traditional CDs.

• Liquid. One of the major drawbacks of CDs is the heavy penalties for withdrawal before the term is up. Liquid CDs avoid that problem, offering the ability to withdraw money without penalty. In exchange, however, you will probably receive a lower interest rate than traditional CDs, and may need to maintain a minimum balance.

• Zero-coupon. In this option, you buy a CD at a deep discount under what you will eventually get after maturity. You do not earn interest over the term. There are significant tax implications with this choice, and may result in you owing tax on money you haven't received. Be sure to understand the intricacies of this option before buying.

• Callable. With this CD, the bank can change the terms before it reaches maturity. You could receive a CD at a fixed interest rate of 6 percent, and after a year market rates drop. The bank will call back your CD and reissue it at 4 percent. You will receive all principal and interest earned to date. Why would you want this option? Financial institutions will pay owners a higher interest rate than traditional or other CDs for this flexibility. Savers must recognize and be comfortable with the increased risk of this type of CD.

Choosing the best CD for you requires understanding all the details and terms of each before investing any money. For questions, do your research online and/or with your financial institution of choice.

For Additional Reading:

Protect Your Money by Checking the Fine Print:
http://www.sec.gov/investor/pubs/certific.htm