Brokered CDs Explained! (Earn Up to 5% Interest!)

What is a Brokered CD? 

A brokered CD is a type of CD or certificate of deposit. You purchase a brokered CD through a brokerage firm rather than directly through a bank. It’s FDIC-insured. CD rates are often higher than a savings account because you have to lock it in for a certain period of time. The terms typically range from 3 months to 10 years. 

Multiple CDs from more than one bank or credit union can be purchased under one brokerage account. The brokers set a minimum investment amount which is usually around $1,000. You can then add funds to a brokered CD in any amount but usually in increments of $1,000. 

No one has been paying attention to CDs since 2008 (Great Recession) because rates have been really low. Previously, you needed to lock your money for a very little return. However, now you can buy a regular 1-year CD at a 4% return; higher if you buy a brokered CD.

How Do Brokered CDs Pay Interest?

The issuing bank will determine when interest is paid on the brokered CD. If the CD term is one year or less, then the interest is usually paid on maturity. If the term is beyond one year then banks generally pay interest semiannually, quarterly, or monthly.

What Makes Brokered CDs Unique? 

  • You can get a much higher CD rate if you buy a brokered CD. 
  • You can only buy these higher-yielding brokered CDs through a brokerage firm, like Vanguard or Fidelity.
  • The minimum investment is typically $1,000. You can also buy Fractional CDs in Fidelity for $100.
  • There is no limit!

Pros of Brokered CDs

  • Liquidity: Traditional CDs require you to keep money in the account for a specified period of time. With a brokered CD, you can sell the CD on the secondary market at any time without an early withdrawal penalty. However, a sales fee may apply.
  • Terms: There are more terms available with brokered CDs than with traditional CDs. Brokered CDs can have terms of 3 months, 6 months, 9 months, and 18 months, which are typically not available for traditional CDs. 
  • Convenience and diversification: You can purchase brokered CDs from more than one bank and keep them in one account. This means that you don’t have to open accounts with a variety of banks to achieve diversification. 
  • Higher interest rates: Brokered CDs typically carry higher interest rates than those found at banks. 
  • Locked interest rate: CDs protect your money from falling interest rates because you lock in your interest rate from opening to maturity.

Cons of Brokered CDs

  • Higher risk: You can potentially lose money if you sell them too soon. 
  • Fees: There are sometimes fees for selling your brokered CDs which can cut your overall earnings. 
  • Callable: Some brokered CDs can be called back before their maturity date. When this happens, then the investment is refunded and you will lose out on any future earnings. 
  • Locked interest rate: CDs are protected from falling interest rates but this also means that it prevents you from taking advantage of rising interest rates. A CD ladder can help minimize this disadvantage.

What is a CD Ladder?

A CD ladder is when you open several CDs each with a different maturity term. When a CD matures, then you can choose another CD to invest in. This means that you can take advantage of the changing interest rates while still allowing you to access portions of your CD regularly.

For example, a CD ladder could involve opening 4 different CDs such as a 3-month CD, a 6-month CD, a 9-month CD, and a 1-year CD. After 3 months, your 3-month CD will mature. You would take the money from that CD and put it into another CD. You would keep doing this so you will always have a CD maturing every three months, in case you need the money.

Can I Withdraw My Brokered CD if Interest Rates Increase?

If interest rates increase you may be tempted to withdraw your brokered CD to buy a higher-yielding CD. We generally recommend that you keep your brokered CD until it matures so you get the full interest. If you sell your brokered CD after interest rates rise, then you will have to sell your CD at a loss.

You can sometimes withdraw CDs without an early withdrawal penalty so check with your institution. You will then need to do a calculation to determine if and when it’s right to withdraw your CD. It’s important to talk to your financial advisor to decide if it’s beneficial for you to withdraw your CD or continue to keep your CD until it matures. 

How Are Brokered CDs Taxed?

The interest that you earn from your brokered CDs and bank CDs are generally considered regular income and subject to federal and state income taxes. If you earn $10 or more in interest in a year then the bank or institution will send you a 1099-INT form to include on your tax return. Even if you don’t receive this form, you are still required to report earned interest on your taxes. It is possible to defer the taxes by holding your CDs in an IRA rather than a taxable brokerage account. 

How Do I Avoid Tax on CD Interest?

The only way to avoid taxes on CD interest is if your CD is purchased in a tax-advantaged account such as an IRA.

What’s the Difference Between a Regular Bank CD and a Brokered CD?

  1. Where you can buy: A brokered CD is offered by brokers and investment firms and is purchased through a brokerage firm. A regular CD is a deposit account that you have to open directly with the issuing bank. 
  2. Early withdrawals: If you withdraw a regular bank CD before the end of a term, you get your money back, forfeit any interest, and maybe pay an early withdrawal penalty. Brokered CDs are unique because you can sell them on the secondary market before the CD even matures. If you sell it on the secondary market then you won’t pay an early withdrawal fee. However, since the price of brokered CDs fluctuates, you may lose money if you sell it early while interest rates are higher than they were when you purchased the CD. You may also need to pay the broker a fee for selling the CD on the secondary market. 
  3. Interest rates: Brokered CDs have a higher percentage yield than regular bank CDs. Brokered CDs usually pay out a simple interest monthly, semi-annually or annually. This is calculated only on the principal since there is no compounding interest.
  4. Diversification: For a brokered CD, you can select a variety of CDs from different banks within one brokerage account. For a regular bank CD, you have to open up different accounts for each CD that you want to purchase. 
  5. Terms. Both regular bank CDs and brokered CDs have various terms, however, brokered CDs usually have more term options available.

What Are Some Similarities Between a Regular Bank CD and a Brokered CD?

  1. Both are issued by a bank.
  2. Both are typically FDIC-insured. Regular bank CDs are always FDIC-insured and the majority of brokered CDs are FDIC-insured. If you purchase brokered CDs, always check that they are FDIC-insured. 
  3. Both offer various term maturities.

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