| Early
withdrawal can erase earnings, drain principal | | |
| "A lot of people put their
money into a CD for the highest available interest rate and then set it up for
monthly withdrawal."
Early-withdrawal penalties are deductible on line
30 of tax form 1040.
There is another way to invest
in CDs and possibly not pay a penalty for early withdrawal. Brokered
CDs, CDs bought through a deposit broker, are sometimes advertised as not having
a penalty for early withdrawal. That's true in that no penalty is levied, but
what you're doing is selling that CD on a secondary market and accepting what
you get for it. You could get less than you paid originally.
Jason Flurry, a certified financial planner and president
of Legacy Partners Financial Group, Woodstock, Ga., says that when
selling a CD on the secondary market your concern is the interest
rate.
If
you have a three-year CD at 5.5-percent interest and you want to sell at a time
when the highest rate on a three-year CD is 4 percent, you'll get a premium for
your CD. But if you're strapped for cash and have to sell when the current best
rate on a three-year is 6 percent, there's less demand for your CD and you may
have to sell it at a discount. "It's a way to escape the
early withdrawal penalty," says Flurry. "But the penalty may be better
than what you can get on the secondary market. You're signing away penalty rights
when you get a brokered CD. "With every investment there's
a benefit and a burden. Typically, you'll get a higher rate with a brokered CD.
That's the benefit. The burden is if you have to cash it in early you have absolutely
no idea what you'll be able to sell it for. At a bank you know the rules up front." Nevertheless,
Flurry says brokered CDs can be the best deal for people who buy and hold. If
you know you're not going to need the money for two years, he advises checking
out two-year brokered CDs - but don't plan on cashing in early. Caution
if it's "callable"
Here's a big, red flag when buying brokered
CDs. Be extremely careful about buying a "callable" CD. These are most
often offered through deposit brokers. The CD may say "federally
insured one-year non-callable." That means the bank that issues the CD can't
call, or redeem, it for one year. But many callable CDs have very long maturities
-- 10 years or more. The U.S. Securities and Exchange Commission
has been warning investors that some brokers are selling the CDs to senior citizens
who may be confused by "one-year non-callable" and think it means the
CD matures in one-year when, in fact, it may not mature for many, many years.
Only the issuing bank has the right to call a CD before maturity. If
you're very sure that a brokered CD is not callable, it can be a good investment
if the term is appropriate for you. But, as Jason Flurry advises, don't buy it
because there's no early-withdrawal penalty; buy it for the yield it generates.
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