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Certificate of Deposit (CD) vs. Checking Account: Which Should You Open?

When it comes to managing your money, keeping large amounts of cash on you at all times isn’t generally considered wise. About 95% of American households include at least one person with a bank account, according to the Federal Deposit Insurance Corporation (FDIC).

Though they are just two of the possible account types offered by most banks, checking accounts and certificates of deposit (CDs) are good places to keep funds, though they each have their own quirks. By understanding those differences, you can more easily decide which is right for you, or whether you want both.

Key Takeaways

  • A CD accrues interest over time with the expectation that the deposited funds will be left untouched for months or years.
  • Checking accounts are liquid. They allow for frequent deposits and withdrawals.
  • The FDIC and the National Credit Union Share Insurance Fund (NCUSIF) insure deposits of up to $250,000 in checking accounts, savings accounts, and CDs at most banks and credit unions.

How a Certificate of Deposit (CD) Works

A certificate of deposit (CD) is an interest-bearing time deposit account that offers a fixed interest rate premium in exchange for a commitment to leave the money untouched for a set amount of time. Think of a CD as a type of loan to a bank. The bank is borrowing money from the customer and paying interest for the privilege.

While nearly every bank and credit union in the country offers CDs to their customers, the terms are up to the bank’s discretion. This includes how long the term will be and how much interest it will earn. Generally, the shortest-term CDs pay a fraction more than a savings account. The longer the term, the higher the interest.

Important

Checking accounts, savings accounts, and CDs are automatically insured by the government for up to $250,000 in losses.

Pros of a CD

  • Accrues interest over time: Generating interest over time is an easy way to get passive income. Since the main idea is to leave the money in a CD untouched, banks and credit unions offer higher interest rates for longer terms. CD interest rates can be as much as several times the national average—if you are willing to commit your money for long enough. In August 2022, the “best” one-year CD rates ranged from 2.50% to 3%. For three-year CD, the rates were about 3% to 3.1%.
  • Fixed interest rates: Most CDs come with fixed interest rates. Regardless of what happens in the financial world during the account’s term, the bank cannot increase or decrease the rate. This is good and bad: an account will never see diminished gains because of lowered interest rates, but it won’t see bigger returns if interest rates increase. Still, you’ll know going in exactly what you’ll get. Variable rate CDs are available but they have their own risks.
  • Helps prepare for future expenses: CDs are great for long-term planning, like saving up for a new car or a down payment on a house. By setting the money aside for a couple of years, you can ensure you won’t tap into those funds for other expenses, as well as calculate how much extra money your CD will make in terms of interest.

Cons of a CD

  • Funds aren’t easily accessible: The biggest characteristic of a CD is the fact that you’re expected to effectively keep your hands out of your cookie jar for a set amount of time. Whether you agreed to several months or several years, that money should be considered out of reach.
  • Early withdrawal is punished by law: Taking money out of a CD before it reaches maturity comes with a federally mandated penalty. Exactly how much you’ll be penalized depends on what’s outlined in the account agreement. Keep in mind that the law sets a minimum penalty but not a maximum limit.
  • Inflation can erase interest gains: Nobody likes inflation, but CD owners are particularly hard hit by the phenomenon. If the national inflation rate exceeds a CD’s interest rate, you’re getting back less money in terms of real spending power than you expected when you deposited the money.

How a Checking Account Works

If a CD means having no access to your funds for a specified time, checking accounts are the exact opposite.

Offered by virtually every bank and credit union in the U.S., checking accounts are very liquid deposit accounts that are designed for regular deposits and withdrawals.

Checking accounts can be accessed by several ways, including automated teller machines (ATMs), electronic debits, debit cards, or paper checks. Financial institutions typically offer a range of account types, including student checking accounts, business or commercial checking accounts, and joint accounts.

Pros of a Checking Account

  • Access your money whenever you need it: Customers can make numerous withdrawals and unlimited deposits without any risk of penalties. With multiple ways to access funds, checking accounts make it easy to pay for everyday costs in addition to major purchases.
  • Diverse account types: Checking accounts come in different types, each with its own unique features, limitations, and benefits. If you need a checking account, it’s likely that one exists to fit your specifications.
  • Set up direct deposit: Thanks to direct deposit, the days of receiving and cashing a paper check for your wages are in the past. By simply filling out some quick documentation with your employer, your funds can be deposited directly into your checking account. In most cases, the money is available for use on payday.

Cons of a Checking Account

  • Zero interest: Most checking accounts are not interest-bearing, so keeping large amounts of cash in one will not yield any return. You’re likely going to want a second account that does accrue interest.
  • Account fees and minimums: Checking accounts generally come with account fees and minimums attached. From overdraft fees for spending more money than you have in your account, to ATM fees for withdrawing cash out-of-network, to monthly service fees to keep your account running, banks charge these additional costs as a way to generate revenue.
  • Easy to overspend: It’s easy to overspend and bounce a check. Luckily, most banks offer online apps that let their customers check their balances at any time.

What Happens to My CD at Maturity?

In the month or two before the maturity date of your CD’, the bank or credit union will notify you of the impending end date. You’ll be given instructions on how to tell them what to do with the maturing funds.

Typically, the bank will offer you three options: Roll over the CD into a new CD at that bank, transfer the funds into another account at that bank, or withdraw the proceeds.

How Can I Avoid Checking Account Fees?

You can avoid some of the fees. Many banks waive some of their fees for accounts with a regularly deposited paycheck. Others waive some fees if a minimum balance is maintained.

Do I Have to Pay Taxes on a CD Account?

Yes. Interest income earned on certificates of deposit is subject to income tax. Since CD interest earnings are taxed as income, the tax percentage you will owe depends on the tax bracket for your overall income.

The Bottom Line

Whether you go with a checking account or a CD, the decision boils down to how much access to your cash you want or need. If you need access to most of your funds at all times, then a checking account may be right for you. If you’re able to live without touching some of your money for a while and want to earn some interest along the way, then you should take a look at CDs in your area.

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