Certificates of Deposit: Tips for Savers
Consumers searching for relatively low-risk investments often turn to certificates of deposit (CDs). A CD is a special type of deposit account with a bank or thrift institution that typically offers a higher rate of interest than a regular savings account. Like all bank deposit products, CDs feature federal deposit insurance up to $250,000, per insured bank, for each account ownership category.
Here’s How CDs Work: When you purchase a CD, you commit to deposit a fixed sum of money for a fixed period of time – six months, one year, five years, or more – and, in exchange, the issuing bank pays you interest, typically at regular intervals. When you cash in or redeem your CD at maturity, you receive the money you originally invested plus any accrued interest. But if you redeem your CD before it matures, you may have to pay an "early withdrawal" penalty or forfeit a portion of the interest you earned. If the issuing bank fails during the term of the CD, the principal balance of the CD, together with interest accrued at the time of the bank’s closure, is insured by the FDIC up to the applicable deposit insurance limit.
Types of CDs Vary: At one time, all CDs paid a fixed interest rate until they reached maturity. Fixed-rate CDs, often referred to as “traditional” CDs, are still the most common. However, more and more banks are offering a greater variety of CD products with a broad range of non-traditional features. For instance, consumers can now find a growing number of banks offering CDs with little or no penalty for early withdrawals, with special redemption features in the event the depositor dies or with provisions giving the bank the right to “call,” or accelerate the CD maturity. In addition, many banks are offering CDs with variable interest rates based on either a pre-set schedule or tied to the performance of a specified market index (such as the S&P 500 or the Dow Jones Industrial Average). These latter CDs are often referred to as index-linked, market-linked, equity-linked, or structured CDs.
CD Accounts Established at an Insured Bank: The most common way to acquire a CD is by opening an account at an FDIC-insured bank. In such cases, the consumer, as the primary depositor named on the CD, can communicate directly with the bank about the account, review and confirm the terms of the account agreement, and obtain assurances that the CD is fully protected by FDIC deposit insurance.
Brokered or Agency CDs: Consumers also purchase CDs through brokerage firms or by using an agent. Common situations involve the use of traditional stock brokerage firms and those firms specializing in the sale of CDs, known as "deposit brokers." Although brokered CDs can be placed directly in the name of an individual depositor, it is more common for brokers to establish co-mingled deposit accounts representing the funds of multiple customers.
A consumer with significant funds to deposit may use a broker to make deposits at multiple banks, thereby maximizing the consumer’s FDIC insurance coverage. In addition, consumers may be attracted to CDs sold by a broker who has made significant deposits in a bank on behalf of multiple depositors and, therefore, is able to negotiate higher CD interest rates than the individual consumer. Be aware, however, that CDs sold by brokers sometimes can be complex and carry more risks than traditional CDs sold directly by banks. An incompetent or unscrupulous broker could mislead or defraud its customers, resulting in loss or theft of the consumers’ funds. Since FDIC insurance coverage only applies if the broker in fact properly establishes and maintains the CD account on your behalf with your funds, it is very important to verify that you are dealing with a reputable broker when purchasing a CD. If the broker mishandles or misappropriates your deposit, your only recourse is against the broker.
Before you consider purchasing a CD from your bank or brokerage firm, make sure you fully understand all of its terms. Carefully read the disclosure statements, including any fine print. And don’t let the promise of high yields deter you from asking detailed questions – and demanding answers – before you invest. The following are issues you should address and other tips that can help you assess what features make sense for you:
- Make sure you are acquiring a CD issued by an FDIC-insured bank – Not all companies with bank-sounding names are actually banks that are insured by the FDIC. To verify that an institution is FDIC-insured, you can use the FDIC’s Bank Find or call the FDIC toll-free at 1(877) 275-3342 (8 a.m. to 8 p.m. Eastern Time, Monday through Friday). The hearing impaired line is 1(800) 925-4618.
If you are purchasing a CD from a broker, you will have to rely on the broker's promise to place your funds into a CD account at an FDIC-insured bank. If the broker breaks this promise, and never places your funds into a bank, you will not be insured by the FDIC.
- Make sure you are acquiring a “deposit” that is insurable by the FDIC – Since some banks offer both deposit as well as non-deposit investment products, it is important to confirm that you are purchasing an insured “deposit.” Before establishing a CD account, make sure that the issuing bank has clearly identified the account as a “deposit” which is subject to FDIC deposit insurance. If you are purchasing the CD through a broker, you should review the account agreement and other supporting documentation to confirm these facts.
- Make sure that the principal amount of the CD is not subject to contractual risk – A financial product cannot qualify as a CD, or any “deposit” for that matter, if it has contractual contingencies. To be a CD, the account agreement must unconditionally obligate the issuing bank to repay the full principal amount of the deposit upon the CD’s maturity.
If an account agreement places conditions on the repayment at maturity of the entire principal balance, or otherwise places the principal at risk for any reason other than the CD’s early redemption, then the product is not a deposit insured by the FDIC, but an investment. In the event of bank failure, customer claims for repayment of amounts due on such non-deposit investments are not insured by the FDIC, but are considered a general creditor claim of the failed bank for which there is usually no return or repayment.
- Find out when the CD matures and if there are any provisions for automatic renewal at maturity – As simple as this sounds, many consumers fail to confirm the maturity dates for their CDs and are later shocked to learn that they have tied up their money for five, ten, or even twenty years. Before you purchase a CD, review the account agreement to confirm the maturity date in writing. Also, find out if the CD will automatically renew at maturity if you do not withdraw the money. If that is the case, find out if the automatic renewal will be at the "old" interest rate or the current rate at the time of the renewal. If market rates have increased, it may not be to your benefit to renew at the old rate.
- You may want to consider “laddering” your CD purchases over different time periods – In establishing CD account(s), be mindful of your potential need for access to the deposited funds prior to maturity. For instance, say you have $100,000 to invest. Although you would like to maximize your earnings, you may be hesitant about investing all of the money on a long term basis. Instead of putting it all into a five-year CD just to get a high, long-term interest rate, you could place $20,000 in a CD that matures in a year, $20,000 in a CD that matures in two years, and so on, which means you will have a CD maturing every year for five years. If you don’t need access to the funds at a CD’s maturity, you could roll each maturing CD into a new 5-year CD. With this strategy you may avoid having to pay an early withdrawal penalty when you need access to some of the $100,000 originally invested in the CD accounts.
- Research any penalties for early withdrawal – Be sure to review your CD account agreement to determine how much you will have to pay if you redeem your CD before maturity. Most CDs will require a depositor to pay a penalty for an early withdrawal. In some cases, the account agreement may provide for a waiver of the early withdrawal fee in the event of the depositor’s death, but there are no laws or regulations requiring banks to make such accommodation.
- Investigate any call features – Some index-linked and other long-term, high-yield CDs have "call" features, meaning that the issuing bank may choose to terminate – or call – the CD after only one year or some other fixed period of time. A callable CD could undermine the depositor’s ability to lock in an attractive interest rate, since a bank could decide to call its high-yield CDs when interest rates fall. Only an issuing bank may call a CD, not the depositor.
- Understand the difference between call features and maturity – Don’t assume that a "federally insured one-year non-callable" CD matures in one year. That language simply may mean that an issuing bank has agreed that for the first year of a multi-year CD it will not exercise its call rights. If you have any doubt, ask the issuing bank or brokerage firm to explain the CD’s call features and to confirm when the CD matures.
- Confirm the terms relating to the accrual and payment of interest on your CD – You should carefully review your CD account agreement and any supporting documentation for the terms relating to interest rate accrual. You will want to confirm the specific rate of interest and whether the rate is fixed or variable. You should also note how often the bank pays interest – for example, monthly, semi-annually or only at maturity – and how you will be paid – for example, by check or by an electronic transfer of funds.
For an index-linked or other variable rate CD, you will want to understand when and how the interest rate can change over the term of the CD. For index-linked CDs, in particular, the contract terms for computing interest can be highly complex and technical, so be very careful to ensure you understand the risks you are assuming before investing in this type of product.
You should also know exactly when interest accrues on your CD. Remember, the FDIC’s obligation to insured depositors is limited to payment of “principal and accrued interest” through the date of the issuing bank’s failure up to the applicable insurance limit. If interest is not accrued on the day of a bank’s failure, then the interest will not be eligible for FDIC deposit insurance coverage.
This is an especially important issue for index-linked CDs, which often provide that interest accrues only at the CD’s maturity. For such CDs, if the bank fails prior to maturity, deposit insurance would only be available for the principal balance, but not for the unaccrued interest which is considered “conditional” and not earned. So, for instance, if interest on a five-year, index-linked CD is payable only upon maturity, and the issuing bank fails one day prior to maturity, FDIC insurance would pay the depositor 100 percent of the CD’s principal balance (up to the applicable deposit insurance limit) and zero for any interest.
- Beware of advertised CD rates far above the competition – As the saying goes “If something sounds too good to be true, it probably is.” Often when interest rates for a “CD” are advertised well above the industry average, the product advertised is either not a CD deposit (and not FDIC-insured) or a CD offered as part of a marketing ploy to sell another financial product (e.g., a life insurance policy or an annuity). In either case any money invested could be at risk.
For instance, a broker may advertise in the local newspaper a 5 percent interest rate on a six-month bank CD. When a customer calls for more information, he or she is told to come to the office to discuss the details. It is not unusual for the customer to then be told that the bank is paying only 5 percent on the first $1,000 of the deposit for a limited period of time — not 5 percent on the entire balance for the full CD term.
Another situation to beware of occurs when a deposit broker markets a CD for which the issuing bank will pay a market interest rate, and the broker will use its own funds to add to the rate of return paid to the consumer. When the CD matures, there is no similar offer on a new CD and the depositor could be steered into purchasing a non-insured investment that may be a poor choice for the consumer but very lucrative for the sellers.
The worst case scenario is that an unscrupulous broker is simply trying to scam you into relinquishing your funds to them based on the promise of a high rate of return on insured deposit.
- Confirm that any CDs acquired from a broker and titled in the broker’s name have been properly established as a “fiduciary account” – Fiduciary accounts are deposit accounts owned by one party, but held in a fiduciary capacity as the deposits of another. If a deposit account satisfies the FDIC disclosure and recordkeeping requirements for fiduciary accounts, then the funds in that account will be insured on a “pass-through” basis as the deposits of the account owner. Accordingly, if your brokered CD is titled in the name of the broker, and not in your name, you should confirm that the deposit account records indicate that the CD is held by the broker on behalf of others (e.g., ABC Investments Client Account or ABC Investments, as Broker). You will also need to confirm that the records maintained by the broker or the bank identify your ownership interest in the account. If these requirements are met, then your share of the CD may qualify for up to $250,000 of FDIC insurance coverage.
- For brokered CDs, confirm that your CD account balance, together with any other deposits held by you at the same issuing bank, are fully protected by FDIC deposit insurance – If you purchase a brokered CD issued by a bank where you already have deposits held in the same ownership capacity, your deposit insurance coverage will be determined by adding together the account balances, including accrued interest, for the brokered CD and the account(s) you opened directly with the bank. If the combined balance of the brokered CD deposit and your personally established account(s) is close to or exceeds $250,000 per bank, you should know that in advance, so you can take action to avoid having uninsured funds at that bank.
- Ask whether your broker can sell your CD – Deposit brokers sometimes advertise that their brokered CDs do not have a prepayment penalty for early withdrawal. That representation is made because the deposit broker will try to resell the CD on the secondary market if you want to redeem it before maturity. If interest rates have fallen since you purchased your CD and demand is high, you may be able to sell the CD for a profit. But if interest rates have risen, there may be less demand for your lower-yielding CD. That means you may have to sell the CD at a discount and lose some of your original deposit. As noted previously, any loss resulting from the purchase or sale of CDs on the secondary market is not covered by FDIC deposit insurance.
- Find out about any additional features – For example, some CDs offer a death benefit that allows a CD owner’s estate to redeem the CD and withdraw the principal and accrued interest without penalty when the owner dies.
If you have a complaint about a CD you purchased through a bank, try to resolve your complaint directly with an officer of the bank before involving an outside agency. Financial institutions value their customers and most will be helpful. If you are unable to resolve the matter with the financial institution, use the following guidelines to determine where to direct your complaint.
If your complaint is against a salesperson who represents a third-party investment firm, contact:
Financial Industry Regulatory Authority (FINRA)
Investor Complaint Center
9509 Key West Avenue
Rockville, MD 20850-3329
Telephone: (301) 590-6500
If your complaint or inquiry is about a specific financial product or investment, contact:
Securities and Exchange Commission (SEC)
Office of Investor Education and Advocacy
100 F Street, N.E.
Washington, DC 20549-0213
Telephone: (800) SEC-0330
If your complaint is about a financial institution or an employee of the financial institution, contact one of the federal agencies listed below:
For either a state-chartered bank that is not a member of the Federal Reserve System, or a state-chartered savings association, contact:
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
Telephone: 1(877) 275-3342 or 1(877) ASK-FDIC
For the hearing impaired call 1(800) 925-4618
Online Customer Assistance Form
For either a national bank or a federally-chartered savings association, contact:
Comptroller of the Currency
Customer Assistance Group
1301 McKinney Street, Suite 3450
Houston, TX 77010
Telephone: (800) 613-6743
For the hearing impaired: (713) 658-0340 or (800)877-8339
Online Customer Complaint Form
For a state-chartered bank that is a member of the Federal Reserve System, contact:
Federal Reserve Consumer Help
P. O. Box 1200
Minneapolis, MN 55480
Telephone: (888) 851-1920
Consumer Complaint Form
Complaints against any financial institution concerning any financial product or service can also be forwarded to the recently-established Consumer Financial Protection Bureau:
Consumer Financial Protection Bureau
P.O. Box 4503
Iowa City, Iowa 52244
Telephone: (855) 411-CFPB 2372
TTY/TDD: (855) 729-CFPB (2372)
Fax: (855) 237-2392
QUESTIONS ABOUT THIS ARTICLE
FDIC Call Center (8:00 a.m. to 8:00 p.m. Eastern Time, Monday through Friday)
1 (877) 275-3342 or 1 (877) ASK-FDIC
For the hearing impaired call 1(800) 925-4618
FDIC on the Internet or Customer Assistance
above information is intended to be presented in a nontechnical way
and is not intended to be a legal interpretation of FDIC regulations