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Should I care when CDs pay interest?

Assuming that I intend to hold a CD until it matures (barring bank failure), is there any reason for me to care when a CD pays interest?

For example, consider a 1-yr CD "A" that pays 3% APY at maturity v. a

1-yr CD "B" that pays 3% APY monthly. Since both rates are the APY, not the compounded interest rate,I believe I would earn $300 on $10,000 in both cases. But with CD "B", I believe the account would be paid about $25 each month, whereas with CD "A", the entire $300 would b paid at maturity.

Assuming that I hold the CD for the full 12 months, is there any reason why that should matter to me?

Now, what if the bank fails after 6 months, for example, and the FDIC pays out the account? Would there be any difference in the amount that the FDIC pays out?

My broker says that the FDIC would pay the prorated interest plus principal (up to the limit, of course). So, it would pay $10,000 plus $150 in both cases, even though no interest had been paid to the account in the case of CD "A".

Is that right?

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Reply to
curiousgeorge408
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Look over the details - what is the frequency of compounding? If it "pays monthly", it probably compounds. BankRate has a calculator for comparing. But it's possible that they have actually adjusted the APY to account for the compounding in their advertised interest rate. They should be advertising

*both* a nominal interest rate and an APY. A bond which compounds monthly and has an APY of 3%, it has a slightly lower nominal yield. The formula is

APY = (1 + (i_nom/N))^N - 1 i_nom = nominal interest rate N = number of periods/yr.

And you can go the other way:

i_nom = N * ((APY + 1)^(1/N) -1)

The nominal interest rate which gets you a 3.0 APY is 2.9595% when you have monthly compounding.

If what you meant by "pays 3% APY monthly" was actually "pays 3% APY, compounded monthly", there you go. Look at the fine print.

If the APY's the same, it should make no difference.

FDIC deposit insurance covers the balance of each depositor's account, dollar-for-dollar, up to the insurance limit, including principal and any accrued interest through the date of the insured bank's closing.

According to the FDIC, that's right.

Reply to
BreadWithSpam

you may or may not want all the interest lumped into one tax year.

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Reply to
123go

If the CD's term is more than 12 months, interest is taxable (and taxed) when it accrues, not when it is paid.

To be concrete, if you have a 12mo CD that pays all interest at maturity that was bought in March 2008 and matures in March 2009, all the interest will be taxable in 2009.

But if you have a 13mo CD that pays all interest at maturity that was bought in March 2008 and matures in April 2009, the interest accrued during 2008 will be taxable in 2008 and the interest accrued during 2009 will be taxable in 2009, regardless of the fact that all the interest was paid out in 2009.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

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Reply to
Rich Carreiro

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Reply to
curiousgeorge408

Thanks for the confirmation.

I have a problem with the word "accrued". Technically, that means (in this context) interest earned, both paid and unpaid. But in the vernacular, I worry that some people might use the term to refer only to paid amounts. I would hope the FDIC web page uses the term correctly.

The only reason why I am suspicious is because I encountered a situation some years ago where the bank paid less than principal plus "accrued" (prorated) interest because the account was closed just a few days before the next interest payment. The unpaid interest was not included in the redeemed amount.

(BTW, Reg DD permits this.)

It would make sense to me that the FDIC feels responsible to pay only the amount in the account, as determined by the __bank's__ procedures. I'm relieved to hear that is not the case, apparently.

If the CD is FDIC insured, the bank must follow Reg DD (aka "Truth In Savings"). The regulation defines the term "APY" to be (only) the compounded rate. So 3% APY returns 3% on the principal, whether the interest rate is compounded daily, monthly or not at all.

In contrast, the regulation uses the term "interest rate" to refer to the nominal annual rate, which may be subject to compounding. So a 3% "interest rate" compounded daily has a different (higher) yield than a

3% "interest rate" compounded monthly.

Reg DD requires only that the APY be advertised. Disclosing the nominal interest rate in advertisement is optional, but explicitly permitted by Reg DD.

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Reply to
curiousgeorge408

I didn't know that (obviously). Will a bank or broker (brokered CDs) 1099 accurately reflect that each year??

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Reply to
Gil Faver

Rich, can you provide a citation -- a reference to an IRS Pub or Form instructions or something else authoritative?

That's what I thought, too. But when I looked for it earlier, I was unable to find an assertive statement to that effect.

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Reply to
curiousgeorge408

"Certificates of deposit and other deferred interest accounts -- If you open any of these accounts, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. **If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.**"

and in that OID section:

"If you buy a CD with a maturity of more than 1 year, you must include in income each year a part of the total interest due and report it in the same manner as other OID."

-- Rich Carreiro snipped-for-privacy@rlcarr.com

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Reply to
Rich Carreiro

"Gil Faver" accurately reflect that each year??

It's supposed to.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

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Reply to
Rich Carreiro

Thanks. This is stated even more clearly on page 14. This is exactly the statement that I remembered and went looking for. Somehow my eyes glossed right over it. Klunk!

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Reply to
curiousgeorge408

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