With interest rates on savings accounts at historic lows, certificates of deposit (CD’s) are on the minds of many. The longer the term, the higher the rate of return. That also means the longer it’s locked up; out of reach for emergencies and/or unexpected life changes. Herein likes the rub with CD’s. You can, of course, access your money earlier than the prescribed term, but penalties can be steep.
What’s An Early Withdrawal Fee?
When you sign up for a CD, the banker across the desk is obligated to tell you about all the money you could lose if you withdraw the funds before the CD matures. Pay close attention here because there is no “norm” or standard policy for early withdrawal. All banks are different. Federal law requires a minimum penalty of seven days interest for early withdrawal on any account called a “time deposit,” but the sky’s the limit when it comes to setting maximum penalty fees. Chase Manhattan Bank sets a good example for charging maximum penalties as their 12-Month CD carries a six-month interest penalty! The most common penalties issued today by banks for early withdrawal can be found in the table below.
|CD Term||Interest Penalty|
|Up to 24 Months||Three Months|
|More than 24 Months||Six Months|
There are instances when early withdrawal will not result in a penalty, but they rarely occur. For example, if the account holder dies or is deemed mentally incompetent, there are outs. There are also loopholes for those over 59 ½ years old. An upside regarding early withdrawal fees is that you can deduct them at tax time.
Comparing Five Year CD Early Withdrawal Penalties
As noted above, different banks have different rules in regard to early withdrawal penalties. If you decide to invest in a CD, you should go in with the mindset that this money is untouchable, but understandably an emergency might throw a wrench into your plan. When looking for the highest CD interest rate available, take into consideration their withdrawal penalties and you might find the highest rate may not always be the best. When you review the penalties for early withdrawal on five year CD’s from some of the most popular online banks, you find Ally stands out amongst the rest.
|Bank Name||Interest Rate (APY)||Early Withdrawal Penalty|
|Discover Bank||1.80||Six Months Simple Interest|
|Ally Bank||1.79||Two Months Interest|
|FNBO Direct||1.75||Six Months Interest|
|Sallie Mae||1.50||Six Months Simple Interest|
You can also see that a fee-free 5-year CD is non-existent. Unfortunately, if you are looking for a “no-risk” CD, you’ll have to sacrifice length and interest rate to do so. Banks now more than ever cannot afford to have you pull money out of your CD early without receiving a penalty. And if they do offer a fee-free no-penalty CD, it may be of little value to you. Below are a few examples of where you can find no-penalty CD’s and the rates and rules they carry.
- Bank of America - 0.4% APY for a 9-month CD with no penalty for early withdrawal after the first six days.
- Virginia Commerce Bank - 1.0% APY on a 12-month CD and a waiver of one early withdrawal fee after the account has been open for 14 days.
Planning Emergencies Ahead of Time By “Laddering” Your CD’s
If you have a knack for numbers or a financial advisor at your disposal, you might look into CD laddering. This is a formulaic, phased-in approach to investing in CD’s that has been likened to dollar-cost averaging with stocks. The goal is to invest at different rates of return, and to never lock up your money for more than a year.
An article found on About.com explains just how a CD ladder works and how it not only can help in emergency situations but also give you the best rate of return.
You end up buying several CD’s at one time but with different maturity dates: one year, two year, three year, four year, and five year CD’s. Every year, one of your CD’s will mature and you can roll it over into a new CD with a longer term (if rates are high) and higher rate.
For example, assume you have $10,000. You research CD rates and identify the bank with the best deals that meet your criteria. Then you purchase five CD’s: CD #1 for $2,000 for a one-year term, CD #2 for $2,000 for a two-year term, CD #3 for $2,000 for a three-year term, CD #4 for $2,000 for a four-year term; and CD #5 for $2,000 for a five-year term.
Each CD is like a rung on a ladder. When the one-year CD matures, roll it over into a new CD for five years (or whatever term you decide to use for your ladder). When the two-year CD matures, roll it over into a new CD for five years. When the three-year CD matures, roll it over into a new CD for five years, etc. You can choose a shorter or longer term when you begin the ladder, but the key is to use the same term for each one once you start rolling them over at maturity.
At the end of five years you’ll have five CD’s with one maturing every year after that, so you’ll never have all of your money tied up long-term or at lower than market interest rates.
CD ladders are a proven method of maximizing your savings but can be complicated for an investing beginner. Make sure that if you choose to ladder your CD’s, you research the benefits and risks in greater detail.
Even though long-term CD interest rates are better than high interest savings account rates, they’re not high enough to make them alluring to all kinds of investors. The fear is that if I invest in a CD today, tomorrow the interest rate will go up. Facing an early withdrawal penalty could force me to keep my money tied up even if I can find better rates elsewhere and that just flat-out stinks. Banks like Ally that offer a one time “raise your rate” CD and also have minimum penalties for early withdrawals certainly make investing in CD’s more attractive but you may want to wait a few months for the economy to stabilize before tying money up in a long-term CD. Once banks open their doors to lending, CD rates will surely begin to rise.