Certificates of deposit (CDs) are a low-risk way to grow your money, offering stable, guarantee dreturns with the security of FDIC insurance. But not all CDs work the same way. Traditional bank CDs and brokered CDs have key differences that can impact your financial planning strategy.

In this article, we’ll break down how each type works and how they can help you build capital for retirement.

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What’s a bank CD?

Bank CDs provide a fixed interest rate in exchange for locking in funds for a predetermined period. Purchasers of CDs often get higher interest rates for giving up access to their money until the CD matures.
This CD type is considered low-risk because of its locked-in rate and the fact that it’s insured up to $250,000 by the Federal Deposit Insurance Company (FDIC) for banks or the National Credit Union Administration (NCUA) for credit unions.

How does a bank CD work?

A bank CD is similar to a savings account, but the terms are more rigid. Unlike a savings deposit account that usually pays a lower interest rate, a bank CD requires you to keep your funds in the account for the CD’s full term.

Because you’re forgoing your liquidity to a certain extent — you can withdraw money if you’re willing to pay the penalty — bank CDs offer a better interest rate than traditional savings accounts.

These CD accounts usually have the following elements:

• Interest rate: Listed as a percentage.
• Compoundment period: Daily, monthly, quarterly, or annually.
• Minimum deposit: The lowest amount of money you can deposit into the CD.
• ‍CD term: The amount of time until the maturity date — typically three months to five years.

• ‍Withdrawal rules: The penalty for removing funds from the CD before maturity.

Say your bank or credit union offers a CD that requires a minimum deposit of $5,000 that pays4% APY compounded annually for a 12-month term, and the penalty for early withdrawal is three months’ interest. If you were to deposit the minimum amount, at the end of the term, you would accrue $200 interest ($5,000 x 4%). And if you were to withdraw the funds before the maturity date, the penalty would be $50 (1% of the principal).

What’s a brokered CD?

Brokered CDs work similarly to bank CDs, but they are purchased through brokerage firms instead of banks or credit unions.

Like bank CDs, brokered CDs require a minimum deposit and have a set interest rate, compoundment period, and term. These accounts are also insured by the FDIC or NCUA, depending on their origin.

Unlike bank CDs, brokered CDs typically have no withdrawal rules.

How do brokered CDs work?

Brokered CDs can be bought and sold on the secondary market, giving you the flexibility to exit your investment before maturity. While their value can fluctuate with market conditions, selling a brokered CD early allows you to avoid the fixed withdrawal penalties that come with traditional CDs.

Interestingly, banks can also sell brokered CDs, but these products are for brokerages, not consumers. Because brokerages are more likely to buy CDs in bulk, the bank can generate amore significant amount of money in a shorter time than it can by selling bank CDs.

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Four differences between brokered CDs and bank CDs

While both brokered CDs and bank CDs offer a secure way to grow your savings, they differ in key ways that can impact your financial planning strategy. From how they’re purchased to their liquidity, here are four major differences to consider.

Purchase process

• Bank CD: Consumers can purchase a bank CD from their bank or credit union. They can often accomplish this online or through an app.
• Brokered CD: Brokerages purchase CDs from a bank or credit union and then offer them on the secondary market. Here, consumers can buy the brokered CDs and resell them.

CD rates

• Bank CD: The banking institution issuing the CD sets the rates according to the market.
• Brokered CD: Brokered CD rates are often higher than with bank CDs because the market can be more competitive.

Liquidity

• Bank CD: They’re less liquid due to early withdrawal penalties. You can still withdraw your money early, but you’ll pay a penalty.
• Brokered CD: Holders can sell these instruments on the secondary market.While there’s no penalty, CD holders sometimes have to sell their CDs at a discount if rates have increased since the purchase time.

Risk

• Bank CD: Because FDIC insurance covers bank CDs up to a prescribed limit, they’re considered low-risk.

• Brokered CD: The risk associated with brokered CDs comes with market fluctuations. For example, if you purchase a brokered CD at a 4% rate but the market CD rates increase to 4.75% during its term, its market value would be less end. The reverse is also true.

Pros and cons of brokered CDs vs. bank CDs

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When it comes to certificates of deposit, there’s no perfect instrument for everyone. Consider the following advantages and disadvantages of each:

• Advantages of bank CDs: Bank CDs offer predictable, fixed interest rates and are insured by the FDIC or NCUA up to coverage limits, making them a safe and straight forward investment.
• Disadvantages of bank CDs: Early withdrawals come with penalties, limiting liquidity.Bank CDs also tend to offer lower interest rates compared to brokered CDs.
• Advantages of brokered CDs: Brokered CDs often feature higher interest rates and access to offerings from multiple insured banks. They also provide liquidity since they can be sold on the secondary market.
• Disadvantages of brokered CDs: Selling before maturity can lead to losses if interest rates rise. This CD type is also less accessible, requiring a brokerage account for purchase.

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FAQ

When should I choose a bank CD vs. a brokered CD?

If your goal is to get a guaranteed rate and you expect to hold the CD to the end of its term, opt for a brokered CD because you’ll get a better interest rate. And if you don’t want to set up a brokerage account and prefer to deal directly with your bank, choose a bank CD.

Are brokered CDs FDIC insured?

Yes. Just like bank CDs, brokered CDs are insured up to the FDIC or NCUA limit — depending on the issuer.

What’s a bank CD account?

A bank CD account is another name for a bank CD. The same applies to a brokered CD account.

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This communication is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice.