Bank Products – Checking Accounts, Savings Accounts, Money Market Accounts & CDs

Most banks offer a great variety of different accounts, but they generally fall within one of these four types: savings accounts, checking accounts, money market deposit accounts, and certificates of deposit. Most banks offer all of these types of accounts although they may fall under different names. With the variety of account types and specialized names that some banks will give their accounts it can be difficult to select what account best suits your needs. It will certainly behoove the prudent shopper to choose the account type they want first, so they can focus on that type of account as they shop around to various banks reviewing the rates, features and fees between competing financial institutions.

Banks offer these financial products and more for their depositors that will have many features that benefit both the bank and the depositor. When you put money into a bank account, you are allowing the bank to use the money you have deposited. Altruism is the primary mission of the U.S. banking system. A deposit account is a specific type of current account at a banking institution that allows money to be deposited and withdrawn by the account holder. There are different types of bank deposit accounts, though, and they pay different rates of interest and have varying restrictions and fees. An account that allows you to write checks, for example, provides you with a definable benefit, so it pays a lower rate than a savings account, which does not offer this benefit. If you agree to leave your funds in a savings account for a specified time without withdrawal, you are providing the bank with some benefits to potential increase their profit. The bank knows for certain that it will keep your deposit, and it knows it can use the funds longer than if you had deposited them in, say, a checking account. In return, the bank will pay you a higher rate than on an account from which you can withdraw your funds at any time.

Within the four categories of bank products, the banking industry and regulators classify the accounts in a different method. These classifications usually pertain to the reserve requirements that the financial institution have to meet and the funds availability rules established by the Federal Reserve. These accounts are usually grouped as follows:

Transaction accounts are:

Checking accounts
Negotiable orders of withdrawal accounts or NOW accounts
Credit Union Share draft accounts
Automatic transfer service (ATS) accounts.

Savings accounts are:

Share accounts at credit unions
Passbook savings accounts
Statement savings accounts
Money market deposit accounts.

Time deposits are:

Certificates of deposits (CDs)
Certain categories of club accounts
Share certificates at credit unions.

The checking account is one of the most common accounts used by the banking consumer. There are many different types of checking accounts – all with various benefits and rules attached. Some are perfect for paying bills and expenses. Some pay interest, and others do not. Some will provide customers with unlimited number of checks while others charge for each check the account holder writes. Some checking accounts require a minimum balance be maintained each month.

Banks will offer differ in the names they give some of these accounts, but the product has changed little over the years. With a checking account you use checks to withdraw your money from the account. You may use checks to pay your bills, purchase products and services (at businesses that accept personal checks), send money to friends and family, and many other common uses. You can also use checks to transfer money into accounts at other financial institutions. You have quick, convenient, and, if needed, frequent-access to your money. Typically, you can make deposits into the checking account as often as you choose. Many institutions will enable you to withdraw or deposit funds at an automated teller machine (ATM) or to pay for purchases at stores with your ATM card. Checking accounts are often divided further into basic checking accounts and interest bearing checking accounts.

Basic Checking Accounts

A checking account is a demand deposit account subject to withdrawal of funds by check. A demand deposit is the most common type of transactional account. Money is available to the account holder without any advance notice or on demand by writing a check, making a withdrawal from an automated teller machine, or transferring funds from one account to another. Checking account features vary widely from institution to institution. Many accounts include fees for blank checks and deposit ticket orders, for the number of checks written, and for returned checks and overdrafts. Other common fees are a general service charge or maintenance fee and a fee if the minimum balance falls below a certain level.

Interest Bearing Checking Accounts

Most types of banks and financial institutions also offer interest bearing checking accounts. These accounts are demand deposit accounts similar to basic checking with the exception that they pay interest to account holders based on the amount of funds in the account. Checking accounts that pay interest were often referred to as negotiable order of withdrawal (NOW) accounts. That term is still used, however most banks use more creative names to label these classes of checking accounts.

The fees found in basic checking accounts may also be found on interest bearing checking accounts as well. In addition, minimum balance fees are more common and there may be a minimum amount needed to open the account. The interest rate on these accounts often depends on how large the balance in the account is and fluctuates greatly from bank to bank. Comparison shopping on demand deposit accounts can be especially important since checking accounts that pay interest charge higher fees than do regular checking accounts, so you could end up paying more in fees than you earn in interest.

Savings Accounts

With savings accounts you can make withdrawals, but you do not have the flexibility of using checks to do so. Funds held in a savings account may not be as convenient as from a demand account. These types of accounts are offered by commercial banks,
savings and loan associations, credit unions, and mutual savings banks they often pay slightly more interest than the checking accounts but can not be used directly as money by writing checks to access the funds.

These accounts are not classified as transaction accounts. However they can generally be easily accesed by ATM or bank branch, instead of writing a check or using a debit card. The transference capabaility in these acounts is easy enough that savings accounts are still considered very liquid.
Some savings accounts require funds to be kept on deposit for a minimum length of time, but most permit unlimited access to funds. U.S bank regulations limit the withdrawals, payments, and transfers that a savings account may perform. Banks comply with these regulations differently; some will immediately prevent the transfer from happening, while others will allow the transfer to occur but will notify the account holder upon violation of the regulation. True savings accounts do not offer check writing privileges, although many institutions will call their higher interest demand accounts or money market accounts savings accounts.

All savings accounts will offer an itemized list of available financial transactions. Some savings accounts charge a fee if your balance falls below a specified minimum.

Passbook savings or bank statement savings are intended to provide an incentive for you to save money. You can make deposits and withdrawals, and though you usually can’t write checks, they usually pay an interest rate that’s higher than a checking account, but lower than a money market account or CD.

Savings accounts will have either a passbook, in which transactions are logged in a small booklet that you keep, or produce a monthly or quarterly statement detailing the transactions. With a passbook savings account you receive a record book in which your deposits and withdrawals are entered to keep track of transactions on your account; this record book must be presented when you make deposits and withdrawals. With a statement savings account, the institution regularly mails you a statement that shows your withdrawals and deposits for the account.

Money Market Deposit Accounts

Money market accounts are a type of savings account offered by financial institutions that behave just like regular savings accounts with some added features. Money market deposit accounts are interest-bearing account that allows you write a limited amount of checks each month. Since the account is not considered a transaction account, it is subject to the regulations on savings accounts. The accounts were created to give banks a product to offer higher interest rates to the depositor and still provide the feature of check writing.

These accounts don’t always, but usually pay higher interest but also have higher minimum balance requirements. As they do with checking accounts, most institutions impose fees on money market accounts.

Since money market accounts such as these are bank accounts, the money in a money market account is insured by the Federal Deposit Insurance Corporation (FDIC). With credit unions, the money in a money market account is insured by the National Credit Union Administration (NCUA), also a federal agency.

These accounts are used by banks to maximize their ability obtain higher rates of return by investing or lending longer term The rates they offer tend to be slightly higher than those on interest-bearing checking accounts, but they usually require a higher minimum balance to start earning interest. These accounts provide only limited check writing privileges (three transfers by check, and six total transfers, per month), and often impose a service fee if your balance falls below a certain level.

Certificates of Deposit (CDs)

Certificates of deposits, or CDs are a form of time deposits. The name, time deposit, aptly sums up the meaning of this type of bank deposit. The key component that differentiates the certificate of deposit from other accounts is that the depositor agrees to leave their funds in the account for a specified period of time. The terms or time periods can range anywhere from one month to ten years. Once the account holder has chosen the term they want, the bank will generally require that you keep your money in the account until that term ends, referred to as the maturity. Because the account holder agrees to leave their funds in the bank for a predetermined period of time, the account holder is compensated with a higher interest rate.

Certificates of deposit provide convenience and ease of investing. In today’s market when consumer are buying a certificate of deposit, the account holder will not usually get an actual certificate but there will be a book entry and it will show up on monthly bank statements. A certificate of deposit is very easy to invest making the certificate of deposit very convenient investment vehicle. Most of the time, you can just walk into a bank and buy a certificate of deposit with a banker. You can also buy a certificate of deposit online without having to open an investment account.

CDs not only provide the guarantee of principal when held in an FDIC insured financial institution, but they are also very easy to manage. When you invest in a CD you know when the term or the maturity is and therefore know exactly when all of your funds become available and you also know what the rate of return you will receive is during that time period. These features along with their suitability in the need to maintain a diversified portfolio have led to the enormous amount of money held in these products.

If something comes up and you need access to your cash, it is possible that you can get your money out of the CD before the maturity date. The maturity is the date by which the issuer promises to repay the investments face value and any remaining accrued interest. However, if you withdraw your funds prior to the maturity date there will most likely be a cost involved. You may have to pay early withdrawal penalty. Penalties vary among banks, and they can often be substantial. The penalty could be greater than the amount of interest earned, so you could lose some of your principal deposit.

CDs come with a variety of different terms and conditions. CDs can be purchased for terms of almost any length or term. When the CD reaches the end of its term, matures, the funds can usually be rollover into another CD at the prevailing market rate of interest. When the CD reaches maturity or the term expires, you can cash out the principal and interest, or roll over the CD for another term at the current market rates being offered by the financial institution you have the CD with. Most banks will continually renew CDs for you after maturity; however, the rate may be different if CD interest rates have changed since you bought the first CD.

CDs have different options when it comes to paying interest on the account. Many CDs will deposit the interest into one of your accounts monthly or quarterly. Other CDs will add the interest back into the CD or pay the interest at the end of the CD term. The issuing bank by and large determines the method of interest payments.

Even though certificates of deposit will generally have higher interest rates than most other bank products, they are still considered one of the safest and conservative investment vehicles out there since the rate of return is relatively low on the accounts and the Federal government up to a limit insures them. The investor of a certificate of deposit can invest small amounts in a certificate of deposit. This availability of small investments in a certificate of deposit differentiates investing in a certificate of deposit from investing in other investment vehicles. A money market security, for example, usually requires a minimum amount of investment for any decent money market rate of return. The ability to invest both small amounts and large sums of money into a certificate of deposit investment makes investing in a certificate of deposit popular among elderly people or parents investing for their children or grandchildren.

The interest rates for CD’s can vary depending on many factors, including; the bank, the credit market, the amount of money you are investing and the length of the term. When looking at the overall picture of CD rates the biggest factors influencing the market for CDs is the length of time until the CD matures, and the current interest rate environment.

How CD Rates are Established

There are two main factors that affect bank CD rates:

• The length of time until the CD matures
• The current interest rate environment

The longer you’ll have your money tied up, the higher your rate will be. Check our rates and you’ll almost always find that banks with the best CD rates go up as the length of time increases. CD’s with longer maturities, time periods, pay higher rates than those with shorter maturities. Generally, the rate paid on the CD with regards to their maturity is the same for all interest bearing investments, the rates increases as the time to maturity or duration increases. This is because the longer you commit to leaving your money, the more flexibility the bank has with your money. They are willing to pay you a better rate because they can use the money for a wider variety of purposes.

The current interest rates environment is also an important factor in determining what the prevailing rates on certificates of deposit may be. That is because bank CD rates are set according to other competitive rates in the market. Interest rates that you earn on all of these deposits are influenced by yields on Treasury billsor short-term corporate IOUs. Yields on these instruments are, in turn, influenced by the Federal Reserve’s decision to cut or raise the fed funds rateas part of its monetary policy. The economy in general combined with forces emanating from the Federal Reserve influence what competitive interest rates are, and that shapes what the market for CD rates are.

Other factors can influence bank CD rates. For example, you may find that a bank is trying to win some short-term business by offering slightly higher rates. They know that there are people out there shopping with banks for the best CD rates, and they hope that once they get a customer in the door the customer will stay.

Risks with CDs

Not all CDs are created equal, so investors need to ask questions and understand exactly what they’re buying. Investors need to learn its maturity date, where the money will be deposited, and the penalties for early withdrawal, any costs associated with selling before maturity and whether the interest rate is fixed or variable.

Because of the inherent safety in certificate of deposits, yields on CDs tend to be lower than other higher risk investments. Like all fixed income paying contracts or investments, CD rates are subject to fluctuations in interest rates. If interest rates rise, the rates on outstanding CDs will generally rise as well. However, since changes in interest rates will have the most effect on longer maturities, short-term CDs are less susceptible to interest rate movements. Interest rate fluctuations are a greater concern for rolling over future investments. The interest rate on a fixed rate CD is fixed until maturity, its rate will not fluctuate. If a CD is sold prior to maturity they are subject to a penalty that limits the liquidity of the investment. The secondary market may also be limited. Some planners will mention the possibility of credit risk, since CDs are a debt instrument, there is credit risk associated with their purchase. The insurance offered by the FDIC mitigates almost all of this risk.

The risk of interest movements can be broken into two different risks, opportunity cost and inflation risk the opportunity cost of a long term fixed interest investment is the inability to now se that money for potential higher paying returns.

Let’s look at your $50,000 one-year CD again. It’s paying you 4%. Assume that prevailing rates have jumped to 6% by the time the maturity date hits. You’ll continue to get your $2,000 per year, even though newly issued CDs earn more. But what if you’d like to get your money out and reinvest at the new, higher rates? With most CDs you will stuck with a early withdrawal penalty.

What are you giving up for the convenience of having a checking account? Consider a bank certificate of deposit that requires an average monthly balance of $1,500 for a checking account. If you can earn 2% a year in interest in a savings account, maintaining this checking account means giving up $30 in potential interest income. If you keep larger balances, you’re sacrificing additional interest income.

Inflation Risk is the risk that a portion of an investment’s return may be eliminated by inflation. All fixed rate investments have the potential for inflation risk. Think of inflation as an invisible tax that erodes the purchasing power of any investment. For example, $10,000 in a certificate of deposit account earns 4 percent interest, but inflation is 3 percent per year. Although this money will earn $400 in interest after one year, inflation cuts the actual worth of this $400 down to $100. In addition, the initial $10,000 will also erode by 3 percent to $9,700. To maintain an investment’s purchasing power, its total return must keep pace with the inflation rate.

While these instruments play an important role in your overall financial plan, especially with the dual qualities of safety and relative liquidity, you need to be aware that they may not protect your assets against all risks.

CD Laddering

CD laddering is method of protecting a segment of your overall investments from the ups and downs in the interest rate market. With a CD ladder bank customers can reduce the risks of a long-term commitment and still take advantage of long-term rates by alternating, or laddering, the CD maturities, so that some are always coming due in the near future but never all at one time. If a CD account holder doesn’t need the cash when one of the CDs matures, they can rotate these maturing certificates back into new long or short term maturities, depending on the CD rates available at the time they mature.

During most normal markets, the interest rate paid by banks on almost type of interest bearing security is greater the longer the term of the deposit. Five year CDs generally pay more than one year CDs. When you pick these longer-term certificates of deposit, you get a better interest rate on your money, but you also possibly lose out if the current interest rates in the market were to increase measurably.

With the CD ladder technique, the account holder distributes their investments over a period of several years with the goal of having several different maturities instead of just large CD that matures all at once. This way part of the money matures annually, and when that money comes back in, he or she can reinvest it over a long period of time. This way the depositor reaps the benefits of the longest term interest rates with an overall higher rate of return while still having enough liquidity to re-invest the money, or withdraw it in short term intervals.

A CD ladder is started by buying several CDs at one or more banks at one time but with different maturity dates, for example, buy a one year term CD, a two year term CD, a three year term CD, a four year, and five year CDs. Every year one of the CDs will mature at different times and can cashed in ort rolled over into a new CD with a similar term at the prevailing best CD rate.

A CD ladder can be as long or as short as you like, but for this example let’s use a five-year ladder with five different maturities or rungs in the ladder. If you have $10,000 to invest, you’d invest $2,500 in each rung. You could put $2,500 in a one-year CD, $2,500 in a two-year CD and continue up to $2,500 in a five-year CD.

After a year, the one-year CD occupying the first rung matures and each of the other CDs has one less year until maturity. In other words, the two-year CD now matures in one-year; the three-year is two years from maturity, etc.

The money from the one-year CD that has just matured is rolled over into the now vacant five-year rung. Every year you’re replacing the rung that’s farthest out — in this case the five-year rung.

You can choose a shorter or longer term when you begin the ladder, but the key is to use the same term for each one once you start rolling them over at maturity. At the end of five years you’ll have five CDs with one maturing every year after that, so you’ll never have all of your money tied up long-term or at lower than market interest rates.

For example, if you have $2,000 to put in CDs, consider putting $500 each in a three-month, six-month, one-year, and two-year certificate. When the three-month CD matures, roll it over into a six-month certificate. Do the same when the first six-month CD matures, and continue rolling over so that you’ll always have a certificate within three months of maturity.

By always replacing the longest maturity, which is the top rung on the ladder, you’re always reaping the benefit of earning the highest interest rates. If interest rates happen to be in a slump one year, you’re only reinvesting a portion of your investment when yields are low. And you don’t have to try to guess when rates are at their highest because you’re constantly reinvesting.

CD laddering is a smart way to protect yourself against fluctuations in interest rates while giving you the security of knowing that you will be able to access at least some of your money within a relatively short time frame. More often than not, the responsibility of maintaining this ladder falls on the investor, rather than the bank. This can be advantageous for banks with competing interest rates, but it can often be a time consuming proposition.

The Truth in Savings Act requires that when a customer opens a certificate of deposit account they must be provided with any information about ladder rates penalty fees for early withdrawal of a portion or all of the funds.

Callable CDs

Most CD accounts offer a fixed interest rate, which means that you will not lose any money if prevailing market interest rates fall. The bank that issues the CD has the exact opposite problem. When rates fall the bank would benefit by paying off or returning the funds on the higher paying CDs and replace them with the lower current interest rate.

A certificate of deposit product that will in fact protect the bank in a falling interest rate environment is the callable CD. The callable CD gives the issuing bank the right to stop paying the agreed rate of interest and call the CD during a set period of time. A callable CD allows the financial institution to redeem your CD after a designated period of time. This right is given to the bank issuing the CD, but they do not give you that same right. If interest rates fall, the issuing bank might call the CD. In that case, you would receive the full amount of your original deposit plus any unpaid accrued interest up to that time. Unlike the bank, you can never call the CD with the bank and get your principal back.

Just like a regular CD, a callable CD is a certificate of deposit that will pay a fixed interest rate over its lifetime. The only feature that differentiates a callable CD from a traditional CD is that the bank owns the call option on the CD and can redeem the CD from you for the full amount before it matures. The incentive for the account holder who has to take the risk that the bank may call the CD is a slightly higher interest rate on the callable CD. Callable CDs will, as a rule, pay more interest than a regular CD. With a callable CD you can earn a higher rate of return but be cautious, if rates drop and the bank wishes to exercise their rate to call your CD, you’ll have to shop for a new one with a lower rate of return. With a regular or traditional CD you incur the risk of a rising interest rates market and can be stuck in a long-term CD paying below market interest rates.

With callable CDs compare the APY of those CDs with comparable term traditional CDs. Be mindful of the call date on the CD. This is the date that the issuer can call your certificate of deposit. Let’s say, for example, that the call date is six months. This means that six months after you buy the CD, the bank can decide whether it wants to take back your CD and return your money with interest. Don’t confuse maturity date with the call date on a callable certificate of deposit. If a CD is described as a one year callable CD, this does not necessarily mature in one year. The one-year refers to the period of time you have before the bank can call or redeem the CD, the actual amount of time until maturity of the CD maybe longer. In fact, it’s not uncommon to find callable CDs with maturities that run for several years, perhaps five to ten year terms or longer. The call date generally does not start for a period of time, protecting the CD holder from allowing the bank to call the CD quickly.

A Callable CD is more likely to be redeemed by the bank when rates decline. If interest rates fall, the bank might be able to borrow money for less than it’s paying you. This means the bank will likely call back the CD and force you to find a new vehicle to invest your money in.

If prevailing interest rates increase, it is not likely that a bank would call a CD. The bank would have no incentive to call a CD that the bank was paying a lower rate on that it would have to pay at the current market conditions. It would simply cost the bank more to borrow these funds elsewhere.

Bump Up CDs

One of the shortcomings of long term CD investments is that while you own the CD interest rates may climb higher and you could be locked into one with a lower rate. To satisfy the need for depositor’s anxiety over changing interest rates when their funds are locked into a term CD, some banks have offered a type of CD called a bump up CD. A bump up CD allows the account holder the ability to bump up the rate on their CD to a higher rate if the current interest rate market during that time has increased. The rate on these CDs is generally slightly lower than a comparable term CD at the start to compensate the bank for the option it provides you. The period of time in which the account holder can exercise the right to increase or bump up to the newer higher rate is also restricted to a predetermined window of time. Most banks offering these CDs also limit the option to increase to a higher rate to just one rate increase during the term of the CD. The potential trade off is when interest rates don’t increase and you will have lost the interest income that is the difference between a regular CD and the bump CDs initial lower rate.

Jumbo CDs

Jumbo CDs are similar to standard certificates of deposit but the initial deposit to open a jumbo CD is much larger. The typical minimum investment for a jumbo is $100,000.00. Like the traditional certificate of deposit, the jumbo CD requires that the account holder leave the principal amount in the account for a predetermined period of time. The term of these CDs vary depending on the bank but are similar in length to traditional CDS as well. Early withdrawal penalties will apply to these CDs, the amount of the penalty will be dependent on the issuing bank. Since the jumbo CD amount is above the initial insured amount of an individual account at an FDIC insure bank, the risk on these accounts are slightly higher. As a rule, the interest paid on the account will also be higher.

Liquid CDs

The inability to access your funds without penalty is a tradeoff when investing for the higher yields that a certificate of deposit offers. To try to satisfy the needs of consumers reluctant to use a CD do to the early penalty withdrawals of CD investments, some banks offer liquid CDs or flexible CDs. Liquid CDs give the account holder the right to withdraw money from the CD without incurring penalties. The money has to stay in the account for designated number of days before the funds can be withdrawn, this is a requirement not only set by the bank but one that is established by the Federal Reserve. The time and number of withdrawals are also limited over the term of the CD. Flexible or liquid CDs will usually have a lower rate than comparable regular CDs that do not provide an early withdrawal option.

If you want your savings to grow at competitive CD rates but you also want to be able to draw on your funds without having to pay traditional CD early withdrawal penalties, a liquid or flexible CD is one option. With these CDs it is important to understand the terms and conditions of the withdrawals as well as the rate of interest paid. Often, the amount of funds that the certificate of deposit holder can withdraw is very limited and a minimum balance must be maintained.

Zero Coupon CDs

Zero coupon CDs or no interest CDs do not have periodic interest payments. These CDs are sold for slightly less than the principal value of the CD at maturity. The technical definition states that the zero coupon CD is originally sold at a discount to its face value. When the CD term ends, the full face value is paid out and the difference between the discounted purchase price and the face value represents the interest on the CD.

They are designed to be sold at a discount and the interest is then the entire amount earned on the investment over the term of the CD. As an example, if you purchased a $1000.00 face value that matures in one year for $890.00, the additional $110.00 that you receive at maturity is the interest paid. The length of term on these CDs is usually for several years. Although you do not receive the interest during the term of the CD, the IRS requires that the interest that is paid at maturity be calculated over the whole term and taxes maybe due based on that interest income as if you had received it.

Variable Rate CDs

Variable rate CDs, also known as floating rate CDs, are CDs that have interest rates that can change. Variable rate CDs pays an interest rate that can adjust to the movement in market interest rates based on an index. The rate paid on these CDs is usually tied to a common interest rate index such as U.S Treasury rates. If rates go up during the term of the CD, the CDs rates can adjust upward, if rates drop, the rate paid on the CD will also drop. These CDs will have conditions that limit the amount of times the CD can adjust during its term as well as a time period during which the adjustment can take place.

These CDs will usually have a slightly lower start rate than a fixed rate CD with comparable terms. The benefit of variable rate CDs is the potential to earn a higher rate should the index the CD is based on rise during its term. Since the start rate is modestly lower, these CDs may be beneficial for those depositors that wish to preserve principal and still have opportunity to earn higher yields without the added risk of non bank or FDIC insured interest bearing assets.

Some factors to consider before buying variable rate or floating rate CDs include:

The index on which the rate paid on the CD is based.
The difference between the rate paid now and the interest rate paid on a fixed rate CD of a similar term.
The time period during which the interest rate can adjust.
The number of times the interest rate may adjust.
The minimum interest rate paid.
The maximum interest rate that can be achieved.
The spread between the index the CD’s rate is based on and the rate that is paid on the CD.

Brokered CDs

Most investors and bank customers traditionally purchase CDs through local banks, however, many brokerage firms now offer high yielding CDs as well. These brokerage firms are sometimes referred to as “deposit brokers”. The brokers can sometimes negotiate higher rates of interest on CDs by pledging to bring a certain quantity of deposits to a financial institution. The deposit broker can then offer these high rate CDs as “brokered CDs” to their own customers.

Since brokered CDs first became a funding alternative in 1982, hundreds of financial institutions have issued CDs for sale to investors through some of America’s most prestigious brokerage firms. 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 be dazzled by high yields. Ask questions – and demand answers – before you invest.

Brokered CDs are CDs issued by banks that are made available to customers through a deposit broker. Nearly all CDs that are sold through brokers are through deposit brokers are securities brokers that are registered with the Securities and Exchange Commission. Some deposit brokers that market and sell CDs are subject to regulation by different regulatory bodies or may not be subject to regulation at all. Though, brokered CDs are made available or purchased through a broker, brokered CDs are direct obligations of the bank that issued the CD, not the broker.

Brokered CDs generally have the features of CDs available directly from banks and are eligible for the same deposit insurance as CDs purchased directly from banks.

Generally, the CD is sold to you without a fee because the broker receives its compensation from the bank. You have a right to know the amount of the fee paid to the broker by the bank. In addition, because federal deposit insurance is limited to a total aggregate amount of $100,000 for each depositor in each bank or thrift institution, it is very important that you know which bank or thrift issued your CD. In other words, find out where the deposit broker plans to deposit your money. Also be sure to ask what record-keeping procedures the deposit broker has in place to assure your CD will have federal deposit insurance.

Brokers may provide additional services to you that would normally be provided by the bank. The broker will hold your CD as your custodian and keep a record of your holdings. The broker will include your CD holdings in the periodic account statements you receive concerning the assets you have with the broker. Tax information concerning the amount of interest you should include in y our income for tax purposes will also be provided by the broker.

Unlike banks, securities brokers are required to provide you with an estimated market value of your CD on your periodic account statement. This is an estimate of the amount you might receive if you were able to sell your CD prior to its maturity. You may not be able to sell your CD for the amount listed on the statement. Also, the amount on the statement does not affect your deposit insurance, which is based on the outstanding principal amount of your CD, not the estimated market value.

When you hold your CD through a broker you have certain rights, including the right to dismiss the broker as your agent and move the CD to an account at another broker or establish the CD directly with the bank. Once you establish the CD directly with the bank your broker has no further obligation with respect to the CD. Within a few days of your CD purchase, a securities broker will provide you with a trade confirmation that sets forth the terms of your CD. In addition, the broker will send you a CD disclosure document describing your rights with respect to the CD, the availability of deposit insurance coverage and other important considerations. The disclosure document will usually be sent with the trade confirmation, but is also available upon request. You should review these documents carefully and ask your broker if you do not understand the terms and conditions of your CD or if the terms and conditions are different than you were told when you placed your order.

Though not obligated to do so, some securities brokers may be willing to purchase, or arrange for the purchase of, your CD prior to maturity. The broker may refer to this activity as a secondary market. This is not early withdrawal. Some brokered CDs are issued in the name of the “custodian” or deposit brokers. In some cases, the deposit broker may advertise that the CD does not have a prepayment penalty for early withdrawal. In those cases, the deposit broker will instead try to resell the CD for you if you want to redeem it before maturity.

The price you receive for selling your CD with a broker will reflect a number of factors, including then-prevailing interest rates, the time remaining until the CD matures, the features of the CD and compensation to the broker for arranging the sale of the CD. Depending on market conditions, you may receive more or less than you paid for your CD. 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. The broker is free to discontinue offering you this service at any time.

Taxable Interest and CDs

Finding the best CD rates may also involve the evaluation of tax rates and tax consequences of the interest earned. You may be able to defer taxes on your CD interest by holding it in an IRA or other retirement account. You may owe taxes when your funds are distributed from those accounts.

You may be required to pay taxes annually on zero-coupon CDs and some conditional interest CDs if you hold the CD outside a retirement account even though these CDs do not pay interest annually. The tax consequence on the original issue discount may be significant even though no interest is paid directly.

Questions about the tax consequences of any particular CD or ownership type should be answered by a tax adviser.

IRA CDs

An IRA is an Individual Retirement Account that is a personal savings plan which provides either a tax-deferred or tax-free way of saving for retirement. There are many different types of accounts of IRAs, depending on the financial goals and situations of each individual, though traditional and Roth IRAs are the most common choices for individuals saving money for retirement purposes.

IRAs are a mainstay for a variety of retirement strategies. By adding a fixed rate certificate of deposit to a retirement plan, an account holder can increase savings with insured and predictable interest earnings. Certificates of deposit are a conservative retirement investment favored by many retirees when the stock market is doing poorly or as a tool for diversification. On fixed rate IRA certificates of deposits the account holder knows what the return is going to be when they are purchased and they are federally insured up to $250,000 when they are bought for individual retirement accounts. In 2006, the FDIC and NCUA raised the insurance limit for IRAs to $250,000 per institution.

An IRA CD can be an invaluable way to generate steady, secure returns and add stability to the stock and bond portions of a retirement portfolio. As long as the amount in the account is within the FDIC insurance thresholds, the account is protected and liquidity can be maintained or managed by selecting different terms of maturity for the IRA. Most IRAs held in bank account are for long term CDs. However, many banks offer a wide variety of term choices for IRA CDs. It may be prudent to actively managing the optimal return by choosing the best CD rate even if it requires evaluating the rate spreads between competing products and varying terms. Choose the best CD rate with appropriate term from 3 months to 5 years, with a broad selection of competitive, tax-advantaged APYs, maximize your return by staying abreast of the market.

An IRA certificate not only allows for the possibility to invest a certain amount of money over a specified period of time, but a IRA CD’s can have considerably higher interest rates in comparison to the traditional saving accounts. As with most CDs. the longer you keep your money in a CD, the higher the interest rate will be. For most CDs, the interest earned within a CD is taxable each year, even if the money is not withdrawn from the CD. However, for CDs purchased within IRA accounts, any applicable taxes come into play upon withdrawal of the funds, rather than as they accumulate.

When a CD is purchased with IRA funds, the federal IRA rules apply. For instance, if you purchase a CD with funds inside of a traditional IRA, the money cannot be withdrawn from the IRA until age 59-1/2 without penalties, or under special circumstances. So, once the CD matures, the money must be reinvested in another CD or other investment vehicle (stocks, mutual funds, annuities, etc.), as long as it stays in the IRA.

Direct IRA CDs have the advantage of complete control of the funds. The CD is opened up under the owner’s title and social security number. Some banks even waive early withdrawal penalties on IRA CDs, often banks do not charge an annual custodial fee either. And with the ability to manage the term of the CDs, if the best CD rate is no longer the best at maturity you can move your funds to another IRA CD with a higher rate.

Some investors in IRA CDs prefer shorter time periods when it comes to the investments, such as 6-month certificates of deposit, while others enjoy the sometimes-higher rates of 3- or 5-year CDs. Flexibility, surety and safety are clearly the overwhelming lure of IRA funds invested in CDs.

This entry was posted on Sunday, October 12th, 2008 at 11:32 am and is filed under Banking and CD Guide. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.