Here’s when an early withdrawal from a CD is worth it

Certificates of deposit can be a great way to save your money. CDs can pay higher interest rates than savings accounts, while backed by Federal Deposit Insurance Corp.

The disadvantage of CDs is that you have to commit to keeping your money in the account for a certain period of time. Each CD has a duration, usually ranging from a few months to a few years. If you try to withdraw money from the CD before the end of its term, you may have to pay a penalty.

However, it might be worth doing an early withdrawal from a CD, despite the cost.

What is an early withdrawal penalty?

When you put money into a CD, you choose a term, like 12 months or 3 years. The CD term is how long you plan to keep your money in the account. Think of it like making a promise to the bank for that duration.

If you try to withdraw money from the CD before the end of the term, you break the promise you made to keep your money in the account. As payment for breaking that promise, you usually have to pay a fee. This is called an early withdrawal penalty.

The cost of an early withdrawal

The amount of penalty you will have to pay will vary depending on a few factors, including:

  • The bank: Each bank sets its own early withdrawal penalties. Before opening a CD, it’s worth checking the fine print of the account to see what fees the bank will charge if you need to withdraw early.
  • The term CD: The term of the CD also tends to impact early withdrawal fees. In general, the longer the duration of a CD, the greater the penalty will be.
  • The yield: Most banks charge early withdrawal fees based on the interest paid by the CD. You might see charges described as three-month interest or 180-day interest. This means that the balance of the CD and its interest rate also have an impact on the fees.

Early withdrawal from a CD is one of the few ways to lose money deposited in an FDIC-insured account. If a CD charges a six month interest penalty and you make a withdrawal three months after opening the account, you will have to forfeit all interest earned and pay the rest of the fees on the capital you deposited.

Here are some examples of CD early withdrawal penalties.

Financial institution 5 year CD 3 year CD CD 1 year
Allied bank 150 days interest 90 days interest 60 days interest
Bank of America 365 days interest 180 days interest 90 days interest
Santander Bank 365 days interest 6 months interest 3 months interest
Capital One 360 6 months interest 6 months interest 3 months interest
To discover 18 months interest 6 months interest 6 months interest

To calculate how much you will pay in early withdrawal penalties, you need to find the amount of interest you earn each day or month, then multiply it by the number of days/months of interest you lose.

When is it a good idea to make an early withdrawal on a CD?

Withdrawing a CD early means paying a penalty. In most cases, it makes sense to leave money on the CD, even if withdrawing early is tempting.

The most common scenario where making an early withdrawal makes sense is if you need money to cover an emergency expense. If your car breaks down or you’re faced with a medical bill you can’t pay, it’s often best to take the hit and use your CD money to pay the bill. The alternative of ignoring the bill means paying interest and penalties and damaging your credit.

Another reason it may be worth paying the fee is if you need to make a large purchase, such as a down payment on a house or car. Paying the penalty isn’t ideal, but if making an early withdrawal makes the difference between being able to make the large purchase or not, you may have to accept the penalty and make the withdrawal.

A rarer situation is when interest rates rise significantly. When you open a CD, you lock in the interest rate for the entire term. If you open a CD when rates are low and they rise significantly, it may be worth breaking your CD to get a higher rate.

For example, if you have to pay a $25 early withdrawal fee, but a new CD with a higher interest rate will earn you $75 more interest, you earn by making an early withdrawal and opening a new CD. However, situations where rates change so drastically are very rare.

If you’re worried about interest rate fluctuations in the future, your best bet is probably to open up short-term CDs so you can access your funds more frequently without penalty.

Consider Investing in a Penalty-Free CD

There are other options for savers who wish to avoid paying early withdrawal fees, including:

  • CD without penalty
  • Covid relief programs
  • CD scales

Penalty-free CDs offer the benefits of traditional CDs: locked-in interest rates and higher rates than many savings accounts, but with fewer drawbacks. The main difference is that you can withdraw your money from the account without paying any penalty. Hence the name.

You also have other options to reduce the chances of you having to pay an early withdrawal penalty. Many banks are waiving fees as part of their COVID-19 relief plans.

You can also try laddering CDs, which involves opening multiple CDs with different terms. If you structure the ladder correctly, you will have more frequent access to some of your money.

Avoid investing money that you cannot afford to lose access to for a while

It’s important to remember that when you open a CD, you agree to keep your money in the bank. Although CDs are FDIC insured, you should consider them an investment.

One of the best tips when investing in the stock market is to make sure you only invest money that you can afford to lose. Likewise, when opening a CD, only deposit funds that you can afford not to have access to for a set amount of time. For example, if you don’t have an emergency fund, you should probably create one before putting all your savings on a CD.

Once you’re financially stable and know you can afford to lock up some of your savings for months or years at a time, you can start considering a CD.

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Jack L. Goldstein