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Early withdrawal can erase earnings, drain principal

Stashing a few certificates of deposit in your portfolio is a good way of investing cash, as long as you hold them to maturity.

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Cash them out early and you'll likely pay early-withdrawal penalties.

No maximum
When buying a CD at a bank, the banker will remind you of the early-withdrawal penalty. But it can be a lot like hearing the side effects of a prescription drug being touted in a TV ad.

All you really hear is, "Ask your doctor about Sneezeless, it will make your allergy symptoms go away." The fast-talking mumble jumble about "may cause hallucinations, sore feet and pimples" gets lost in the euphoria of knowing you won't sneeze anymore.

You may focus so much on the interest rate and term of a CD that you don't pay enough attention to the chatter about how much money you'll give up if you cash the CD early.

Federal law requires a minimum penalty of seven days interest for early withdrawal on any account classified as a time deposit. Since the law doesn't set a maximum penalty, banks are free to, and usually do, charge much more.

It's not unusual to see the following penalties:

CD term
Interest penalty
All interest
Two to 18 months
Three months
Two years or more
Six months

Some institutions levy even stiffer penalties. Chase Manhattan charges 180 days interest for early withdrawal on a 12-month CD.

And it's not just mega-banks that charge high rates. Community Savings, based in Riviera Beach, Fla., charges six months interest for early withdrawal of any CD with a term of more than one-year.

Banks count on your money
Banks have a vested interest in making sure you don't yank your money out from under them.

"We view CDs as one of a number of very important investment tools, not only for the safety and soundness of a financial institution, but also for the better returns than a money market and less risk than the stock market," says Dave Huiskens, first vice president at Detroit-based Comerica.

"But offsetting the security and the slightly better yield is the fact that the bank is looking to keep those funds around and share in the profitability."

Some banks, such as Comerica, don't state the specific penalty at the time of purchase. The penalty will be determined using a formula driven, in part, by the maturity point of the CD, according to Huiskens.

"The earlier the withdrawal is made in the term, the larger the penalty," he says. "The current market rate at the time of withdrawal would also be considered."

What's worse than forfeiting interest you've earned? Forfeiting interest you haven't earned.

Suppose you bought an 18-month CD at Chase and decided to cash it out after four months. You would have to pay six-months interest even though you've only earned four. That means you're digging into the principal you paid for the CD.

On the other hand, early withdrawal penalties are sometimes waived.

Penalty-free early withdrawals
"There are some exceptions," says Theresa Brooks of Community Savings. "It's waived if someone dies or is declared mentally incompetent. Most institutions will also waive it on an IRA or 401(k) for anyone over 59 ½.

Next: Be extremely careful about buying a "callable" CD
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