Simple Facts About Saving With Certificates of Deposit Accounts

A certificate of deposit, more generally referred to as a CD, is categorized as a time deposit. It is a promissory note provided by financial institutions in exchange for depositing funds during a specified term the course of which they cannot be accessed. CDs accrue interest during this term, generally at a higher rate than an average savings account, and are paid upon maturity. Money withdrawn from a CD before its maturity date usually incurs a penalty. The fixed terms offered vary from 3 months, 6 months, 12 months, up to 5 years.

Certificates of deposit are considered a relatively risk free investment as they are FDIC insured,

Currently the higher 1 year CD rates (one year CD rates) are averaging 1.55%, however these numbers vary based on different factors, including location and the amount of deposit. Generally these fluctuations have a bigger effect on CDs with longer maturity dates versus those that are considered short term, which tend to be less disposed to shifts in interest rates. CD interest rates are calculated based on the term of the CD and the current interest rate environment. The rate is usually higher the longer the term or the larger the sum deposited. However, once the CD is purchased and the money deposited, the return is not subject to stock market fluctuations, the earnings on the funds are guaranteed.

Withdrawals made before a CD reaches maturity generally incur a substantial penalty. For example, a five year CD might suffer a loss of 6 months worth of interest. The penalties are in place to ensure the investor keeps the funds in deposit until maturity. The penalties may or may not affect the principal deposit, if for example it is withdrawn after three months of opening with an established six month penalty. Sometimes withdrawal of the principal may require that the entire CD be closed.

Deposit brokers also offer certificates of deposit, often these brokerage firms can negotiate higher 1 year CD rates (one year CD rates) by promising to bring a certain amount of deposits to the financial institution it represents. These CDs are usually issued in large denominations and are then split up in to smaller values and resold to customers. For this reason, brokered CDs are often advertised as having no prepayment penalty associated. In the event an investor wishes to redeem the CD before maturity, the broker can attempt to resell the CD, at times even for a profit. These certificates of deposit are also insured by the FDIC however in the event the bank fails, brokered claims take a little longer to pay than the traditional direct deposit CD.

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The Truth About FDIC and Certificates of Deposit (CDs)

When you are told by a banker or receive a promotional letter from a financial institution regarding a special Certificate of Deposit (CD) rate, please think before you act. Most bankers love CD's simply because it will lock your money into a product that will charge a substantial fee if withdrawn prior to maturity. In addition most bankers get a commission for new money deposited into a CD. When I was a banker, I had always been one of the few that disliked CD's for many reasons. I find them only useful for very few things. Since I am no longer a banker I want to give you the dirty truth behind CD's that most do not know and what is your REAL rate of return from those "promotional" CD's you find online or in your current bank.

First off, CD's are a fixed income vehicle that is backed by the FDIC. Many people trust the FDIC for its insurance and the deposit is in fact guaranteed (up to $250,000 per DEPOSITOR until 12/31/2013). What you most likely did not know is how you get paid and when. You are covered up to this a certain amount but the time it takes to pay you however is never documented. From my research and what I was taught years ago as a banker is the following: The FDIC can take up to 99 years to pay (not a typo)! There is no public documentation of how long it takes to pay however based on the fact that if ANYTHING catastrophic was to occur financially, the FDIC will have time to pay. So if you expect immediate payment with a simple claim of lost funds from an FDIC insured product, you are sadly mistaken. The FDIC is also an INDEPENDENT AGENCY of the federal government. They receive no congressional appropriations (money) and it's fully funded by the premiums (payments) from banks and thrift institutions pay per deposit coverage as well as earnings from U.S. Treasuries. Most people do not have to worry however since most major banks are more than willing to buyout smaller/failing financial institutions in order to acquire more clients and show positive PR (public relations) to the masses. This has shown more than enough evidence with what has happened in 2008-2009.

FDIC products are fully taxed. If you purchase a CD, the growth will be fully taxes (state, federal, local) just as if you have earned this income from working. This is based on your tax bracket which is as follows (2010):

Bracket / Single / Married:

10% Bracket / $0 - $8,375 / $0 - $16,750

15% Bracket / $8,375 - $34,000 / $16,750 - $68,000

25% Bracket / $34,000 - $82,400 / $68,000 - $137,300

28% Bracket / $82,400 - $171,850 / $137,300 - $209,250

33% Bracket / $171,850 - $373,650 / $209,250 - $373,650

35% Bracket / $373,650+ / $373,650+

Now, most of you that purchase CD's are aware of this. However, what most fail to realize that CD's do NOT catch up with the rate of inflation. The rate of inflation is measured by the CPI (Consumer Price Index, I have described what this details on a previous article which can be found in my previous post). For whatever investment, income, or interest you earn to not match or exceed the CPI, you are losing money long term. This is a volatile index but long term averages around 2.5%. This means you must earn either 2.5% or more AFTER TAXES long term in order to maintain your cost of living life style.

For example: You are in a 25% bracket and have purchased a 12 month CD at 2% APY for $50,000. You earned $1,010 from the interest which equals 51,010 but you have to pay taxes on the growth (your tax bracket) which will equal to $253. You have earned after FEDERAL taxes $757 (some state and local taxes may occur that will lower your return even further!). Now here is where most people do not pay attention to, the CPI for the year. Let's be fair and say it is 1.6% for the year (less than the average, just to make a point). You would need to earn $800 AFTER TAXES from that 50,000 in order to keep up with the rate of inflation. Your real rate of return is negative $43. In order to keep up with this rate of inflation you would need to find a CD with the rate of (approximately) 2.8% or higher depending on what state you live in. Please remember that we are talking about a tax payer in the 25% bracket which is considered the national average. These rates become considerably higher if you're considered "High-Net-Worth".

Not all CD's are bad. If you are one of many that cannot withstand volatility what-so-ever than it is best to purchase CD's within a IRA this way taxes are deferred or Roth IRA which no taxes are paid after withdrawal (please see my article on IRA's for details). Also, CD's are probably the best product to purchase if you are planning on using the money short-term and cannot risk ANY volatility. Short-term can be considered 2 years or less. I highly recommend CD's for home buyers (in 2 years or less) since the deposit in your home are tax deductable therefore the taxes on interests earned on a CD will be taken care of.

There are many considerably safe products that have low maturity dates and have considerably better returns than a CD. In the end, before you purchase the CD, know what your intentions are and when do you think you're going to need it. If it's for educational purposes, there are products that can be a better option for you and your child (529 plans, UGMA/UTMA for example). If it's for medical bills, there are products out there for that as well (Health saving plans). The point is to use a CD only for short term purchases that can be tax deductable or within tax favor accounts. Many people use CDs to prepare for a birthday or holiday in that year and that is OK as well! The key is "short-term". If it is for emergency funds, your best bet is to simply put it in a money market where there won't be any implications or charges for early withdrawal.

I hope I was able to educate you on CDs and now more aware of what you are getting into. If you have any questions or concerns please feel free to contact me!

Resources:

FDIC: http://www.fdic.gov/about/learn/symbol/index.html

SIFMA Calculators: http://www.investinginbonds.com/story.asp?id=207

Financial Consultant, Risk Manager, Insurance Agent, and Retirement Planner here to give honest opinions on the current financial trends. (*Please note: If you have ANY questions, please feel free to contact me. I will be more than happy to chat with you!). [http://www.MichaelAponte.Biz]

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Are Your Bank Deposits Safe? Financial Facts - What You Need to Know About Your Savings

If your bank deposits are covered by the Federal Deposit Insurance Corporation (FDIC), your money is safe up to $100,000 personally and $250,000 in eligible retirement plans. In fact, depending on how you have structured your accounts, coverage can significantly exceed $100,000 per bank. We have been negative on the outlook for U.S. Bank stocks since early last summer, but FDIC insurance has added a level of safety since its inception shortly after the Great Depression. Social Security and greater flexibility by the Federal Reserve to inject liquidity into the financial system are two other key safety measures helping to prevent another 1929-type collapse.

One of the biggest risks regarding this country's current financial malaise is more from a "crisis of confidence" in which worries about the banking system creates a run on certain banks, forcing otherwise solvent banks into insolvency.

This is one reason the Fed acted so swiftly when problems erupted with Bear Stearns in March, and more recently, took measures to instill confidence in both Fannie Mae and Freddie Mac with promises of financial backing. Only a year and a half ago, the number of troubled banks on the FDIC list were at record lows, as most banks were enjoying record earnings and soaring stock market valuations. Excess liquidity brought on by historically low interest rates coupled with relaxed, or non-existent, loan covenants created a massive bubble in real estate that has pushed a growing number of banks to the edge. This problem was many years in the making and with real estate representing approximately 60% of all bank assets, investors should not expect a dramatic turn around anytime soon. It is important to keep in mind that the plight of many bank stocks, with many down 70% or more over the past year, does not necessarily correlate with the safety of your deposits in these banks. As long as you make sure all of your bank accounts are FDIC insured you will be fine, and there is definitely no reason to panic. But what are the rules and stipulations of FDIC insurance?

FDIC insurance was started in 1933 after thousands of banks failed following the stock market crash of 1929. The deposit insurance coverage was initially set at $2,500 and steadily increased until it was raised to the current amount of $100,000 in 1980. The FDIC has the power to increase the insurance limits on all deposits every five years, based on inflation, but has demonstrated a very conservative stance by electing not to do so.

In April of 2006, the FDIC established $250,000 of insurance coverage for deposits that are held in IRA and select other retirement accounts. It should be noted that accounts not covered by FDIC include mutual funds, annuities, life insurance policies, stocks and bonds. In addition, an uninsured money market mutual fund should not be confused with an FDIC-insured money market deposit account.

After the first quarter of 2008, the FDIC released its list of 90 troubled banks, up from 53 in the first quarter of 2007 and 76 in the fourth quarter. Very few banks that make the list are destined for failure. Among all the troubled banks listed last year, only three actually failed. The recent collapse of IndyMac was a shocker to many, as the bank wasn't even on the FDIC's watch list. After its failure, it was reported that IndyMac received 100% of FDIC insured funds, and 50% of non-insured funds. Many times in the past, uninsured deposits have been partially insured, but there is no guarantee that trend will continue. For trust account holders, depositors have to wait to get their deposits until the beneficiaries of trusts can be verified.

It is important that you take the necessary steps to help navigate through this crisis:

1. Don't panic. Confirm that all of your assets in banks (savings accounts, checking accounts, money market deposit accounts and certificates of deposits) are insured up to the $100,000 per account and $250,000 per retirement account. For example, make sure if you have a joint account with over $100,000 that it is structured properly to receive up to $200,000 of coverage.

2. Establish a secondary banking relationship to have liquid assets (emergency money) available from two separate sources, should your bank become insolvent. This can also be helpful to compare yields and fees to make sure you're getting the most from your bank for every dollar of savings. Remember that insured deposits in trust accounts may not be immediately accessible and recovery of broker CDs may also experience delays.

3. If you have considerable assets, consider the Certificate of Deposit Account Registry Service (CDARS), a program designed to accept deposits of more than $100,000 and still receive FDIC coverage by spreading funds among many FDIC insured institutions. Your deposits can be insured for up to $50M with CDARS without having to set up accounts at multiple banks.

One final point - as with all banking relationships, yields are negotiable. The current credit crisis has created strong demand for loyal "credit worthy" clients so investors have never been in a better position to negotiate the best rates, and lowest fees, for each banking deposit or service.

Article presented by LanczGlobal.com

Alan B. Lancz is a nationally recognized authority on investing and financial analysis. He is the president of Alan B. Lancz & Associates, Inc. (http://www.ABLonline.com), a registered investment advisory firm and Director of Research at LanczGlobal.com (http://www.LanczGlobal.com).

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