What Are Brokered CDs? How They Compare to Traditional CDs

Not long ago, CDs were seen as investments for the timid — one personal finance celebrity mocked them as “certificates of depression” due to their low yields and lock-up periods. 

It’s easy to see why: CD rates from 2010 to 2021 predominantly hovered under 1%. But the post-pandemic interest rate hikes in 2022 and onwards resulted in average CD rates not seen in nearly 20 years!

Those higher yields generated renewed interest in CDs, and while you may be familiar with the traditional CDs you get at your bank or credit union, brokered CDs are another option to consider.

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What Is a Brokered CD?

Most people are familiar with a traditional certificate of deposit (CD): You open it directly with a bank or credit union and agree to hold the CD for a specified duration in exchange for a specific amount of interest. 

Redeeming the CD early incurs a penalty — generally the interest for a set period.

But a brokered CD dispenses with most of that. 

Instead, a brokerage (like Fidelity or Vanguard) will buy a single large CD, possibly in the millions of dollars, from an issuing bank and then sell smaller quantities of that CD to individual investors, typically in $1,000 increments. 

Unlike a traditional CD, which can only be redeemed back to the issuing bank, a brokered CD can be sold at any time on the secondary market to other individual investors. 

The trade incurs a nominal fee from the brokerage for the transaction but there isn’t an interest penalty from the issuing bank.

How interest rates affect brokered CDs  

Like a bond, brokered CDs will trade at either a premium or a discount depending on current interest rates. 

For example, if you buy a brokered CD with a 5% yield and sell it later after interest rates drop to 4%, you would get a premium for your CD because it pays above market yields. 

But if interest rates rise after your purchase, you would take a discount on your CD since a buyer could purchase a new-issue CD at the higher market rate. 

If you hold to maturity, you will get the issuing rate at the time of purchase. 

RELATED: What Is the Federal Reserve and the Fed Funds Rate?

Brokered CDs vs. Traditional CDs

The primary difference between brokered and traditional CDs is liquidity. 

With a traditional CD, early withdrawals will cost you a penalty equal to the amount of interest you would have earned. 

For example, a common early withdrawal penalty on a one-year CD is the interest for a 90-day period. Longer-term CDs will typically have larger penalties. 

But early access to your funds in a brokered CD will require selling it on the secondary market with discounts and premiums similar to bonds.

Another significant difference is the way interest is paid. 

With a traditional CD, interest is typically compounded back into the product. But brokered CDs, particularly long-duration CDs, will pay interest into another account. Shorter-term CDs will pay interest at maturity. 

Both traditional and brokered CDs are covered by FDIC insurance and subject to the limit of $250,000 per customer, per issuer. (If you exceed the limit, you can simply open an account at multiple banks.) 

But the limit doesn’t apply to a brokerage account, just the issuers inside it.

	Brokered CD	Traditional CD
Original issuer	Bank or credit union	Bank or credit union
Purchase location	Brokerage firm	Issuing bank or credit union
Early access to funds	Sell on secondary market	Pay penalty
FDIC protection	Yes, to FDIC limits, but the $250,000 issuer limit does not apply to brokerage account, only per issuing bank	Yes, to FDIC limits: $250,000 per account owner, per issuer
Interest payments	Typically, periodic to another account or at maturity	Typically, compounding or at maturity
Terms available	1 month to 20 years	3 months to 5 years (some banks offer 10-year terms)
Minimum deposits	$100 to $1,000	$500 to $1,000, varies per issuer

Pros and Cons of Brokered CDs 

Pros

• Easy to purchase and you can buy or sell on the secondary market. 
• Rates tend to be higher than traditional CDs.
• Many brokerages have automated CD laddering tools with automatic reinvestments at maturity.
• FDIC limits can be expanded within a single brokerage account.
• Longer terms are available than with traditional bank CDs.

Cons

• Selling on the secondary market can expose you to interest rate risk in a rising rate environment.
• Callable CDs are more common with brokered products. With a callable CD, the issuer can “call” the CD and return your principal with earned interest if rates drop. Read the fine print when you purchase!
• Buying or selling on the secondary market incurs trading fees — typically $1 per $1,000 at major brokerages.

READ MORE: Are CDs Worth It?

How To Invest in Brokered CDs

It’s very easy to invest in a brokered CD. You simply need a brokerage account and funds available to trade. 

All the major (and most smaller) brokerages offer CD products. However, small online trading platforms haven’t typically offered CDs.

You can review the offerings, read terms and yields, and select one that meets your investment goals. The purchase is just like you would trade any other stock or bond in your portfolio. 

Interest payments and the return of principal are directly back into your brokerage account.

How to choose a brokered CD

When selecting a CD, it is important to note:

• Account minimums
• Term lengths
• How interest will be paid 

With brokered CDs, $1,000 is the most common minimum, although fractional CDs are a newer option with minimums as low as $100. 

It is also important to determine if the CD is callable by the issuing bank and how interest payments are made. Long-term CDs will typically pay interest monthly or quarterly. Short-term CDs will pay at maturity.

 

FAQs

How is the interest on a brokered CD taxed? 

Interest income on a brokered CD is taxed as ordinary income just like a traditional CD. 

The brokerage will issue you a form 1099-INT each year showing the amount of interest income you have earned and is subject to tax. 

TL;DR: Are Brokered CDs Worth It?

Brokered CDs offer a flexible alternative to traditional CDs, with more options and potentially higher yields. However, it's important to understand the nuances like interest rate risks and potential trading fees.

Before diving in, consider how brokered CDs fit into your overall investment strategy. Read the fine print about callable features and understand how interest payments and secondary market sales work. 

As with any investment, do your homework so you can make the most of your money!

For more tips on saving and investing, check out these episodes of the Erika Taught Me podcast:

• How To Invest for Beginners (Step by Step)
• Money & Investing Pitfalls to Avoid
• Investing Advice from the Most Powerful Woman on Wall Street

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