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Banks offer plenty of CD options to suit your needs

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When looking for a certificate of deposit, there’s a tendency to just check the minimum required, terms and the interest rate. Plain vanilla stuff.

But, you can find plenty of other options by shopping around a bit — options that can help you build a tailor-made CD portfolio.

No-penalty CDs
Ever buy a one-year CD at, say, 5.5 percent interest and then a couple months later the bank’s offering 5.75 percent for the same amount of money?

You can avoid that by buying a no-penalty CD.

If interest rates go up, cash in the CD and trade up to the higher rate without a penalty and you’ll get interest for the time you held the original CD. Each institution offering no-penalty CDs has a minimum number of days that you’re required to hold the original CD. By federal law it can be no less than seven days.

“It’s a good seller, an excellent feature certificate,” says Brad Howard of Maryland Bank and Trust in Waldorf, Md. “It offers the ability to get a better rate without penalty. We have a lot of competition, and it’s a competitive edge.”

No-penalty CDs are good for those who stay on top of interest rates and want to get the most for their money. But Terry Kane of Wilmington Trust in Wilmington, Del., says they’re especially good for people who have specific funding needs.

“They’re anticipating funding for a major expenditure such as college. They’re watching the market and anticipating that rates are going up.”

Sometimes you’ll find that the yield on a no penalty CD is lower than the yield on a regular CD and some banks also require a fairly steep minimum. But shop around. You’ll find some institutions offering them for $500 at a competitive rate.

Zero-coupon CDs
Most investors have heard of zero-coupon bonds, but did you know there are also zero-coupon CDs? Just as with a bond, you buy the CD at a deep discount to par value (the amount you’ll get when the CD matures). The word “coupon” refers to an interest payment. Zero coupon means no interest payments.

For instance, you might be able to buy a 10-year, $100,000 CD with a 7-percent interest rate for $50,000. You don’t receive any periodic interest payments during the 10 years as you would with a traditional CD. Instead, that money is being reinvested. The result is one of the things you have to be aware of when considering zero coupon CDs, says Scott Walker of Alexandria Financial Associates in Alexandria, Va.

“You have phantom income each year. No money is being put in your pocket, but you have to take some money out of your pocket to pay Uncle Sam because the tax is paid based on accretion.”

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So, the $100,000 CD you paid $50,000 for is accruing interest at 7 percent a year — that’s $3500 Uncle Sam wants you to pay taxes on the first year. $3500 you haven’t actually received. Each year you’ll have a higher base than the year before and that means a bigger tax bill each year — so make sure you have the funds to cover the taxes.

Walker says there can be another downside to not receiving periodic cash interest payments.

“If interest rates go up, you don’t get the benefit of getting cash payments and reinvesting that money at higher market rates. But if rates drop you’ll be happy you bought the zero because you’ll be reinvesting at the stated rates instead of taking cash and having to reinvest at lower rates.”

If you buy a zero-coupon CD from a broker, know if it’s callable. Callable means the broker can demand that the CD be redeemed after a stated period, usually one year. Just as with any CD, if rates drop you’re a happy camper because you’re locked in to a higher rate, but if your CD is callable that may be when it gets called out from under you.

Pick your own maturity date
Selecting the exact day you want your CD to mature can ensure your money is earning the highest interest rate right up to the day you need it. Some banks have chosen this feature as another way of letting customers tailor their CD portfolio.

Robin Binkley, a vice president at Juniper Bank, an online bank based in Wilmington, Del., says this feature appeals to people who like to super-manage their money as well as people who like to take a more hands-off approach.

“They’re super busy with their lives, their kids and jobs. It’s important to them to have the ability to customize their CDs, so they don’t have to find a home for that money until they have a use for it,” says Binkley. “Suppose they want to take a vacation and they have to pay for it on May 15th. They can have their CD mature on the 14th and give the money to the travel agency on the 15th. It makes it easy for them to manage their money.”

It makes sense if you need your money in 95 days; why park it in a 90-day CD and then have to settle for putting it in a lower-rate money market for the remaining five days?

As always with CDs, make sure you’re buying it from an institution in good standing and know what penalties exist for early withdrawal.

— Posted: Jan. 12, 2001