CD Interest: Let It Accrue or Receive Regular Payments?
To maximize your interest earnings on a certificate of deposit (CD), you should let interest accrue over the account’s term.
If you leave your account alone, a monthly paying CD does reinvest interest. You’ll get this benefit with other interest payment terms, too, as long as your CD pays out interest at some point before the account matures. This enables you to earn interest on your interest, otherwise known as compound interest.
But if you need to get access to some of the funds in your account, withdrawing interest on a CD before maturity is your best bet to avoid early withdrawal penalties — assuming you don’t have a no-penalty CD.
What determines the frequency of your CD interest payments?
The financial institution that issues your CD will set the frequency of your CD interest payments. You should be able to review this term before you open the account.
Possible intervals include monthly, quarterly, annually and when the CD matures. CDs frequently add interest payments to an account’s principal balance at a monthly interval.
Interest payment frequency can be linked to the length of your CD term. For example, CDs from Chase with terms longer than a year will pay interest at least annually.
What are your disbursement options for CD interest?
CD interest can be disbursed in two ways:
- You can allow the interest in your account to accrue until the CD matures, when you can choose to cash out or renew the CD.
- You may be able to collect regular interest payments without the penalties that generally come with early withdrawals from CDs.
Accumulation
If you opt for CD interest accumulation, you’re letting your account sit until its maturity date. You’ll be able to decide whether to renew the CD (with changes) or close the CD after it matures.
Letting interest accumulate will allow you to unlock the annual percentage yield (APY) the account advertises. On the downside, the funds in your CD will remain locked up for the account’s term. This inaccessibility may be a positive if you’re saving for a particular goal and you want to leave the funds untouched.
Many CDs automatically renew, so make sure you have a plan before the account hits maturity. You’ll likely also have a grace period after renewal when you can make changes to your account — seven or 10 days is common. Keeping organized is especially important if you’ve built a CD ladder.
Regular payment
Your financial institution may let you receive interest payouts at regular or irregular intervals during your CD’s term.
For example, American Express permits monthly interest payment transfers to your bank account. Alternatively, you can receive a check monthly, quarterly or annually.
In contrast, West Union Bank is less flexible: Customers can make one penalty-free interest withdrawal per term.
Regular interest payments are helpful if you want or need access to some of the funds in the CD before the account matures. You may also want to consider a high-yield savings account if you want to earn interest but think you’ll need more frequent access to your funds than a CD provides.
What’s the best option to maximize CD interest?
The best option to maximize CD interest is letting interest accrue.
The account’s APY is likely calculated assuming you aren’t making interest withdrawals. If you opt for withdrawals, you’ll earn less because your account’s interest will compound on a lower balance.
That said, you probably won’t notice a major difference in your earnings if you take out some interest early. If you need cash sooner than the CD’s maturity date, withdrawing interest isn’t a bad option — and it’s certainly preferable to an early withdrawal from a CD, which can result in penalties.
Early withdrawal penalties typically involve sacrificing a significant amount of your interest earnings.
How is the interest on CDs taxed?
CD earnings are taxable as income. You can use the Form 1099-INT you receive in January when you file your taxes.
You’ll have to pay taxes on your CD interest earnings regardless of whether you let interest accrue or receive regular payments.
The amount you’ll be taxed on will differ slightly depending on the option you choose, because a CD that regularly pays out interest will earn less compared with, say, a monthly paying CD that reinvests interest.
“It’s almost a wash from a tax perspective,” says George Gagliardi, a certified financial planner and founder of Coromandel Wealth Strategies.