CD vs. High-yield savings account: What's the difference?

This content has been reviewed and edited by an Investment Advisor Representative working for Global Predictions, an SEC-registered Investment Advisor.

When it comes to saving your money wisely, there are several options to choose from. Among them, Certificates of Deposit (CDs) and high-yield savings accounts are two of the most popular. But which one is right for you? This guide explains the differences between CDs and high-yield savings accounts to help you decide where to place your savings.

Key Takeaways

• Stability of CDs: CDs mostly offer a fixed rate and greater stability but require a time commitment.
• Flexibility of High-Yield Savings Accounts: High-yield savings accounts often allow easy access to your money, but rates may vary.
• Goal-Based Choice: CDs are often best suited for long-term financial goals, while high-yield savings accounts work well for short-term savings and emergency funds.

What Is a Certificate of Deposit (CD)?

A Certificate of Deposit, or CD, is a type of savings account offered by banks and credit unions that pays a fixed interest rate for a specific term. The main difference between a CD and a regular savings account is that with a CD, you agree to leave your money in the account for a set period, which can range from a few months to several years. In exchange for locking in your funds, you typically earn a higher interest rate.

• Fixed Interest Rate: CDs offer a fixed rate of return, meaning your interest rate will not change over the CD’s term. This can be advantageous if you’re looking for stability. (Note: CD interest rates can vary depending on the financial environment. Check current rates with your institution before investing).
• Commitment to the Investment Period: With a CD, you commit your funds for a specific period. If you need to withdraw money before the term ends, you’ll likely face a penalty. Early withdrawal penalties on CDs vary widely based on the financial institution and term length. Typically, short-term CDs (e.g., 12-month CDs) may incur a penalty of 60–90 days of interest, while longer-term CDs (e.g., 5-year CDs) may impose a penalty of 180 days or even up to a full year of interest. Some banks now offer no-penalty CDs, which allow you to access funds without penalties before maturity. Checking with your bank for specifics is best since these penalties are institution-specific and can differ significantly.

Hypothetical Example: Imagine you deposit $5,000 into a 3-year CD with an annual interest rate of 2%, compounded annually. Over the 3-year term, the interest will compound, meaning you earn interest not only on your original deposit but also on the interest accrued in previous years.

At maturity, the total balance would be approximately $5,306.04. This includes your original deposit of $5,000 and $306.04 earned in compounded interest. However, if you need to access your funds before the term ends, you may face an early withdrawal penalty, which could reduce your total earnings.

What Is a High-Yield Savings Account?

A high-yield savings account is similar to a traditional savings account but offers a significantly higher interest rate. These accounts are typically offered by online banks or financial institutions, which can afford to provide higher rates due to lower overhead costs.

• Higher Interest Rates: High-yield savings accounts offer significantly higher returns compared to regular savings accounts, making them attractive for those who want to grow their savings without a fixed term. (Note: High-yield savings account rates can also fluctuate; check current rates before investing).
• Easy Access to Funds: Unlike CDs, high-yield savings accounts allow you to access your money at any time. You can withdraw funds without penalties, giving you more flexibility.

Hypothetical Example: Suppose you put $5,000 into a high-yield savings account with an interest rate of 1.5%. You can add or withdraw money whenever you need, making it a good option if you want to keep your funds accessible for unexpected expenses.

Comparing CDs and High-Yield Savings Accounts

Short-Term vs. Long-Term Savings Goals

• CDs for Long-Term Savings: CDs are ideal for long-term financial goals. By locking in your money for extended periods, you gain a fixed rate of return, providing predictability for goals like buying a house, funding future education, or saving for retirement.
• High-Yield Savings Accounts for Accessibility and Short-Term Goals: High-yield savings accounts are better suited for short-term goals, especially if you need easy access to your money. They are an excellent choice for emergency funds, seasonal expenses, or savings that may be needed in the near future.

Tax Considerations

The interest earned from both CDs and high-yield savings accounts is generally taxable. This interest is reported as part of your taxable income for the year, even if the interest is reinvested. For precise guidance, you can reference the IRS guidelines on taxable interest income. Hypothetical Tax Impact Example: Suppose you earn $100 in interest on your high-yield savings account or CD. Depending on your income level, this $100 may be added to your taxable income for the year, and you might pay taxes on it based on your income tax bracket. It’s important to consider the tax impact when choosing between these savings options.

FAQs About CDs and High-Yield Savings Accounts

Can I withdraw money from a CD before it matures?

Yes, but most CDs charge an early withdrawal penalty, which could impact your total earnings.

Are high-yield savings accounts safe?

Yes, as long as they’re in an FDIC-insured bank. Both CDs and high-yield savings accounts are covered by FDIC insurance, which protects deposits up to $250,000 per depositor, per insured bank. This coverage is automatic for any FDIC-insured institution and ensures deposit safety in the event of bank failure (Learn more about FDIC insurance).

What’s the impact of fluctuating interest rates?

In a high-yield savings account, interest rates can vary with the market, meaning you could earn more (or less) over time.

Common Financial Terms Glossary

• Interest Rate: The percentage charged on top of the deposit amount, representing the return on investment.
• Early Withdrawal Penalty: A fee charged if you withdraw money from a CD before its maturity date.
• Maturity: The date when the CD term ends, and funds are available for withdrawal without penalties.
• FDIC Insurance: Assurance that deposits are protected up to a certain limit in case of bank failure.