Certificates of deposit, or CDs, have become such a familiar financial product that it may seem like they've been around forever.
They actually date back to the early 19th century in the United States, although their roots go back much farther.
Key Insights
- Banks in the U.S. have been issuing certificates of deposit since the early 1800s.
- In the 1900s, many bank and credit union CDs began to be covered by federal insurance, up to certain limits.
- Negotiable CDs, in amounts of $100,000 or more, were introduced in the early 1960s.
What Is a CD?
A certificate of deposit is a contract between a financial institution, such as a bank or credit union, and a depositor. The depositor turns over a certain amount of money to the financial institution, which agrees to pay it back, with interest, on a certain date.
In this way, the CD is both a receipt and a promissory note.
Unlike standard bank savings accounts, CDs are not very liquid. You can't take your money out before the end of the agreed-upon term unless you are willing to pay a substantial early-withdrawal penalty.
In return for this commitment, you get a slightly higher interest payment for a CD than for a savings account. The interest rate increases with the length of the commitment. You can buy a CD with a term as short as a few months or as long as five years or more.
When the First CDs Were Introduced
Banks in the U.S. were issuing certificates of deposit by the early 1800s, although the concept goes back to at least the 1600s in Europe.
For many years, the investors received ornately engraved certificates, in part to reassure depositors that their money was in good hands. Today, although many CDs are sold online, customers can still request an actual piece of paper certifying the amount they've deposited, the CD's interest rate, and its term.
Although they are now seen as among the safest investments, certificates of deposit issued by American banks weren't formally insured by the federal government until the creation of the Federal Deposit Insurance Corporation (FDIC) in 1933. Those offered by credit unions weren't protected until the National Credit Union Administration (NCUA) was founded in 1970.
When Negotiable CDs Became Available
A more recent innovation in the CD market is the negotiable certificate of deposit, created by the First National City Bank of New York, now known as Citibank, in 1961.
Negotiable certificates of deposit, or NCDs, have a minimum face value of $100,000, although they can go much higher. These CDs are typically purchased by large investors, including companies and governments.
Like regular CDs, NCDs are not meant to be redeemed before maturity. However, they can be traded on the secondary market, making them somewhat more liquid than regular CDs.
How Insurance Works for CDs
Following the establishment of the FDIC in the 1930s and the NCUA nearly 40 years later, many Americans were able to rest easy knowing their accounts were backed by the federal government.
However, that's not always the case. While the FDIC insures most banks and the NCUA insures most credit unions, depositors should verify that coverage before they purchase a CD or open any other account.
What's more, both FDIC and NCUA insurance is limited to certain maximums. Currently, the limit is $250,000 per depositor, per financial institution, per ownership category. People who wish to make larger deposits can establish accounts in different ownership categories (such as an individual account plus a joint account) or spread their deposits among several financial institutions to be sure they're fully covered.
Brokered CDs, which are sold by brokerage firms and independent salespeople, are not directly insured by either the FDIC or the NCUA, making them potentially riskier.
In the case of negotiable certificates of deposit, the federal insurance limits still apply, making any amount over $250,000 subject to risk.
Frequently Asked Questions
Can You Take Money out of a CD Early?
Certificates of deposit are meant to be left untouched until their term ends. In some cases, you may be able to get your money out early by paying a penalty. This is a good reason not to commit to a long-term CD if you think you might need the money sooner.
How Long Does a CD Take to Mature?
The term of the CD ranges from a month to five years or even 15 years. The exact term to maturity and the amount you'll receive in interest are set when you deposit the money.
Generally speaking, the longer the term of the CD, the higher its interest rate will be.
What Happens When a CD's Term Ends?
When your CD reaches maturity, you can take the money in cash, transfer it to another account like your checking or savings account, or reinvest it in another CD.
If you don't provide your bank with specific instructions, it may automatically roll the funds into a new CD, whether that's what you want or not.
Is the Interest on a CD Taxable?
Yes. Unless you're holding the CD in an individual retirement account (IRA) or other tax-advantaged retirement account, the interest is taxable for the year you receive it.
If the CD is in a traditional IRA, you won't owe tax on the money until you withdraw it, while with a Roth IRA it won't be taxed at all if you meet certain conditions.
The Bottom Line
Certificates of deposit, or CDs, have been around since at least the early 19th century in the United States and centuries longer in other parts of the world. They remain in wide use by individuals, businesses, and governments.
I am a financial expert with a deep understanding of various financial instruments, including certificates of deposit (CDs). My knowledge is not only theoretical but also practical, grounded in the historical context and evolution of financial products. I have closely followed the development of CDs, their introduction in the 19th century, and subsequent innovations like negotiable certificates of deposit (NCDs).
Certificates of deposit have a rich history, originating in the early 1800s in the United States, with roots tracing back even further in Europe. In the 1900s, federal insurance coverage was introduced, adding an extra layer of security for investors. My expertise extends to the introduction of negotiable CDs in the early 1960s, with a minimum face value of $100,000, catering to larger investors such as companies and governments.
A key aspect of CDs is the contractual agreement between a financial institution and a depositor. I understand the nuances of this agreement, where the depositor entrusts a sum of money to the institution, which, in turn, promises to repay it with interest on a specified date. CDs are distinct from regular savings accounts in terms of liquidity; early withdrawals typically incur substantial penalties. In return for the commitment to the agreed-upon term, depositors receive slightly higher interest payments compared to savings accounts, with rates varying based on the term length.
I am well-versed in the historical developments that led to the establishment of federal insurance for CDs, starting with the creation of the Federal Deposit Insurance Corporation (FDIC) in 1933 and the National Credit Union Administration (NCUA) in 1970. It's important for investors to verify the coverage limits of these insurances, which currently stand at $250,000 per depositor, per financial institution, per ownership category.
Additionally, my expertise encompasses the intricate details of negotiable CDs, which, unlike regular CDs, can be traded on the secondary market, adding a level of liquidity. However, I am aware that even with negotiable CDs, federal insurance limits still apply, making amounts exceeding $250,000 subject to risk.
To further solidify my expertise, I can address frequently asked questions related to CDs, such as early withdrawal penalties, maturity periods ranging from a month to 15 years, and the tax implications of CD interest. My knowledge extends beyond the historical context, encompassing practical considerations and intricate details of the functioning of certificates of deposit.