How to Make $1,000 a Year With CDs

Certificates of deposit (CDs) earn interest at a fixed rate that's determined at the beginning of its term. The guaranteed returns that come from a CD make these bank products a great addition to a passive income strategy -- especially if you have savings to work with. These days, it's easy to find the best CDs paying out at 5% APY for short terms (a year or less) and 4% to 4.5% for longer ones. With these rates locked in, it's not unheard of to earn $1,000 or more annually for the next two to five years. Here's how.

Lock in today's rates with a long CD ladder

One way to earn $1,000 annually with CDs is to build a CD ladder. This involves spreading your savings across several CDs with different terms to both increase access to your funds and, in this case, take advantage of great rates on short and long CD terms. One example would be to open five CDs with one year separating their maturities. To yield $1,000 a year, here's what such a CD ladder might look like.

In this scenario, you would need a total of $46,739 to make $1,000 annually in CD interest over the next five years.

Notice the inverse relationship between terms and initial deposits. As the terms increase, the deposit required to yield $1,000 decreases. Whereas you need $19,048 to get $1,000 in a year (with a 5.25% APY), you would need significantly less ($4,268) to yield $1,000 in year five at a 4.30% APY.

Alternatively, if you didn't need access to your money, you would net significantly more by investing a large lump sum in a long-term CD, like one lasting five years. For example, if you put $46,739 in a 5-year CD with a 4.30% APY, you would earn a total of $10,961.06 in interest over that period -- an annual average of more than $2,000. To average $1,000 annually, you would only need to invest $21,340 in a 5-year CD with the same rate.

Beware the tax liability

The interest on CDs is taxable, just like with other bank accounts that earn interest. CD interest totaling $10 or more must be reported on your annual tax return. The rate from your tax bracket is the same rate used to tax your CD earnings. What's more, if you live in a state that levies income taxes, you have to pay state taxes on your CD interest, too. Because of this, both federal and state taxes could reduce your $1,000 CD interest to a lower amount.

One way around this is to open your CDs within a tax-advantaged retirement account, like an IRA. Many of the best IRA accounts allow you to invest in CDs, though they'll likely be brokered CDs.

This type of CD differs from bank CDs in a few ways, most notably in that you can sell brokered CDs on a secondary market. Brokered CDs also earn by simple interest, not compound interest, so you'll need slightly more than the initial deposits mentioned above to earn $1,000 annually. Still, brokered CDs have competitive interest rates and can shield you from tax liabilities if you hold them within an IRA or 401(k).

All in all, you can earn $1,000 on CDs annually by locking in today's best rates on both short and long terms. Whether you already have a passive income strategy or you're looking to start one, check out today's best CDs for the terms mentioned above and lock in rates before they change.