Pros and cons of CD early withdrawal
A bank certificate of deposit, known as a CD, can be a tempting target if you need cash in a hurry. But should you break your commitment to the bank and yourself to keep a big chunk of change in a CD for a specified period of time?
One reason to ditch a CD before the end of the term might be the paltry interest rate, says Arlen Olberding, owner of Guidepost Financial Planning in Fort Collins, Colorado.
CD rates today are "not very attractive," Olberding says. "People lock money in for two or three years at 1 percent when you can get a money market for 0.8 or 0.9 percent, so why do it?"
Olberding is far from the only expert to express disdain for CD rates.
Still, there are risks and penalties for CD early withdrawal, so it's smart to consider the pros and cons before you metaphorically smash your CD piggy bank.
Dump CD for better investment?
Since CD rates are so low, early withdrawal can make sense to invest in a different way that might offer a higher return.
Whether you choose a different CD or another option altogether, you should have a plan before you make any investment, says Kent Grealish, an hourly rate investment planner with Grealish Investment Counseling in San Bruno, California.
The question to ask yourself is: "Does 100 percent of this money absolutely, positively have to be safe or does 75 percent of it have to be absolutely, positively safe, and I can take 25 percent and a little bit of principal risk and a little bit of liquidity risk to get a higher rate?" Grealish says. "You have a CD bucket and an I-can-take-a-little-risk bucket."
Taking on risk
If you opt for risk, proceed with caution. A CD will stabilize your source of investment income, but other investments can be more volatile, says Frank Boucher, owner of Boucher Financial Planning Services in Reston, Virginia.
"If you're looking at breaking a CD to chase down a stock that might pay a higher dividend, that might not be a good strategy," he says.
A CD can be useful to lock up money you're saving for a major purchase, even one with uncertain timing such as a down payment for a house.
"If you've found a home you want to live in or feel you want to use for an investment, with interest rates being as low as they are on CDs, I wouldn't let the interest penalty deter me at all as far as breaking the CD and using that money," Boucher says.
On the other hand, a CD isn't a good place to find funds to pay for living expenses or splurge on unnecessary and unplanned purchases.
"Your CD's an investment and you want to treat it as such," Boucher says. "That's one reason why you have the CD. You think twice before you do something like that."
Is it an emergency?
True emergencies are unpredictable, but you should still plan to have cash at the ready and not locked up in a CD when unexpected expenses prove necessary.
For that reason, Olberding says it's better to keep emergency funds in a money market or savings account.
If you've already put your savings into a CD and now you need the cash early, compare the cost of CD early withdrawal with other options such as a brokerage margin account or home equity line of credit, Grealish says.