Add-On CDs

An add-on is a special type of CD that allows an account holder to make additional deposits to an account any time prior to maturity, whereas a traditional CD entails a single, upfront deposit.

A traditional certificate of deposit (CD) is a type of savings account offered by banks and credit unions to their customers. It provides the account holder a guaranteed rate of interest in exchange for a commitment to leave their savings in the account for a specified amount of time. Generally, early withdrawal of the money will trigger a loss-of-interest penalty.

The process for investing in an add-on CD begins the same way as the opening of a traditional CD. You are required to apply in-person or online with the issuing financial institution. The primary difference is that for a traditional CD, the principal invested will not change, but for an add-on CD, you have the option to increase the amount of principal invested.

For illustrative purposes, consider the following example:

• You buy a $10,000 add-on CD on January 1, 2023.
• The term is five years (maturity on January 1, 2028), with an annual percentage rate (APY) of 4%. Interest is paid annually.
• Add-on deposits are permissible at the account holder’s discretion.

During the first year, you earn $400 of interest ($10,000 × 0.04 = $400). Then, at the beginning of each subsequent year, you make add-on deposits of $2,000.

The issuing financial institution may limit the number of deposits that can be put into an add-on CD account. It may also cap the total amount of money that can be deposited into the account.

Beyond the ability to make additional deposits, there are a few other notable differences between add-on CDs and traditional CDs.

Certificates of deposit are arguably the safest investment vehicles in which you can invest. When structured properly, a CD is fully insured up to $250,000 for an individual account and $500,000 for a joint account.

The Federal Deposit Insurance Corporation (FDIC) insures CDs issued by banks, while the National Credit Union Administration (NCUA) insures CDs issued by credit unions.

However, CDs also have a few notable disadvantages.

For longer-maturity CDs, a significant disadvantage is inflation risk. For these instruments, a spike in inflation can overshadow the fixed-rate income they provide. Ultimately, this reduces the purchasing power of CD investors.

Another notable disadvantage is the inherent illiquidity of CDs. As mentioned above, CDs require you to lockup your money for a specified amount of time. Early withdrawals are subject to loss-of-interest penalties and, in some situations, loss of principal is possible.

An add-on CD provides some protection against liquidity risk, given the fact it allows for incremental deposits. So, once a deposit is made, it is subject to a lockup requirement.

A CD is a good idea for anyone that seeks a high-quality, stable-value investment that kicks off guaranteed interest and is willing and able to lockup cash for a specified amount of time. For many people, CDs serve as a relatively short-term complement to a broader portfolio of long-term holdings, including stocks, bonds and alternative investments.

When it comes to investing in an add-on CD or a traditional CD, the most important considerations are the amount of investable cash you have and the flexibility you desire. An add-on CD is optimal for an investor that has a relatively small amount of investable cash and values the ability to add to an investment when their budgetary situation allows for it.