Even the most conservative investment options come with some degree of risk.
Savers interested in CDs can earn a higher yield than the one tied to their traditional savings account. But you could lose money if you can’t keep the account open until maturity. These penalties — known as early withdrawal penalties — can be costly. But at times, taking the L and cashing out a CD before it comes due could be worth it.
Deciding whether to ditch a CD before it matures isn’t easy and shouldn’t be done without considering certain factors, like the tax implications of such a move.
The cost of an early withdrawal
Early withdrawal penalties can vary depending on the length of the CD term and the bank offering the account. CDs with longer terms usually pay higher rates, but the early withdrawal penalties for these accounts tend to be harsher.
At TAB Bank in Ogden, Utah, for example, the penalty for CDs maturing in 12 months or less is 90 days of interest on the amount withdrawn. For CDs with longer terms, you could forfeit 180 days of interest. Below are the early withdrawal penalties for CDs offered by several popular banks.
|Financial institution||5-year CD||3-year CD||1-year CD|
|Ally Bank||150 days of interest||90 days of interest||60 days of interest|
|Capital One Bank||180 days of interest||180 days of interest||90 days of interest|
|Marcus by Goldman Sachs||270 days of simple interest||270 days of simple interest||270 days of simple interest|
|Wells Fargo Bank||360 days of interest||360 days of interest||90 days of interest|
|Bank of America||360 days of interest||180 days of interest||90 days of interest|
Calculating exactly how much interest you could lose from an early withdrawal penalty can vary depending on the formula used by your bank or credit union. For example, if the penalty depends on the amount withdrawn and you withdraw $1,000 early from a 4-year CD with an interest rate of 2.75 percent, the penalty could be $16.50 (a loss of 180 days of interest).
Typically, you’ll just lose interest when you make an early withdrawal from a CD. But if you haven’t earned enough interest to cover the penalty, most banks won’t hesitate to take part of your principal (your original deposit) to satisfy the penalty, says Greg McBride, CFA, Bankrate’s chief financial analyst.
Also keep in mind that few banks allow partial withdrawals from CDs. Even if you want to take out just a portion of your original deposit and some of the interest you’ve earned, you may have to close the whole account.
Justifying an early withdrawal
Withdrawing your savings from a CD before it matures could be tempting, particularly if interest rates start to rise after you’ve locked money up in an account. But trying to time rates is almost as hard as trying to time the market, says Jamie Hopkins, director of retirement research at Carson Group, a wealth management firm based in Omaha.
If rates are moving up and you’re thinking about breaking your CD, you’ll ultimately have to crunch some numbers. Calculate how much interest you’ll earn if you keep your money in your current CD versus pulling it out and parking it elsewhere. Since earnings from a CD are taxed, make sure you consider how much money you’ll have left after taxes.
“If the penalty is less than the additional interest you can earn after taxes by reinvesting the money, then it’s worthwhile,” McBride says.
If you’re concerned about what rates could look like in the future, Hopkins recommends opting for short-term CDs or bonds. If rates go up, you’ll at least have the opportunity to take advantage of some of the deals while they’re available.
Avoiding early withdrawal penalties
Breaking a CD may not be the best option because penalties can cut into the amount of interest you’re earning. Going with an account that’s more liquid could work in your favor.
With a no-penalty CD, for example, you won’t be penalized for closing out your CD before it matures. Many of the no-penalty CDs offered by the banks today, however, are short-term CDs, meaning they’re helpful only if you’re trying to meet short-term savings goals. What’s more, with these accounts, yields tend to be lower than the ones associated with traditional CDs.
Keeping your money in a savings account might make more sense than tying it up in a CD. Some money market accounts also offer competitive yields relative to what CDs offer, Hopkins says. By putting your savings in either of these accounts, you avoid dealing with early withdrawal penalties altogether (although you can be penalized for opening a savings account and closing it within a short period of time).
Another option is to compare CDs and choose one that allows you to regularly withdraw your interest or transfer it to your checking account, without touching the principal balance. Since the interest in your CD will likely compound, however, this reduces the amount of interest you’ll ultimately earn. Another tip: Keep tabs on the date your CD matures. Your bank or credit union should contact you letting you know that your account will be due soon, but it’s easy to overlook these messages if you’re not careful.
Staying organized and being aware of your maturity date will ensure you withdraw your savings at the end of your term. CDs often auto-renew. In other words, you don’t want to end up facing an early withdrawal penalty when a new term automatically begins but you want to reinvest your money in a different account.