What Is A CD Early Withdrawal Penalty & How To Avoid It

CDs are great investments for those who are looking to keep their money safe. Funds can be FDIC-insured, and you will earn more interest than you would from a savings account.

What is a Certificate of Deposit?

A certificate of deposit is an account offered by banks that have a set amount of money and set amount of time. Some CD accounts have minimum opening  deposit requirements, but there are some that don’t have any at all. As with any savings account, you’ll also want to look for CDs with high interest rates.

Banks will pay interest on your deposit on a regular basis (usually monthly) until the CD matures.  That period of time is called the term length, and it usually ranges from six months to five years. You might be able to find some as short as four weeks or as long as 10 years. Generally speaking, the longer the term length, the higher the rate.

• Available nationwide online • Discover offers CDs with some of the highest and most competitive rates! • Select terms as short as 3 months up to 120 months • Rates ranging from 2.00% APY up to 4.00% APY. • Opening a Discover Bank Certificate of Deposit is extremely quick and easy. • Funds on deposit are FDIC-insured up to the maximum allowed by law. • Get started and open a Discover CD in 3 easy steps. Apply Now at Discover

Reason for CD Penalties

When you invest your money into a CD account, the bank wants to keep your money invested for certain period of time (term length). Banks use this money that you invest to reinvest into other investment options.

In return of letting them use your money, they are willing to pay you a higher interest rate return. The bank benefits from having certainty about how long it can use your money.

Because banks reinvest your money into other investments that have maturities as well, by demanding your money early, the bank might have to pay its own form of penalty elsewhere.

Cost of CD Early Withdrawal Penalties

If you are planning to take money out of your account, the earlier you withdraw money from your CD, the less interest you will earn. And in most cases, you’ll also have to pay some sort of penalty for withdrawing money before maturity.

Every bank has its own rules for penalties. In most cases, this could be a specified number of months’ worth of interest.

Although there may be exceptions to this rule, you should understand your CD’s withdrawal conditions, just in case the need arises. These aren’t always the same across the board, so be sure to reach out to your credit union or bank before signing up for an account.

How You Can Avoid CD Early Withdrawal Penalties

Some banks issue interest payment disbursements throughout the term of your CD, which is one way to access money from your CD without incurring an early withdrawal penalty.

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 also 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.

Some CDs allow for early withdrawal penalties to be waived outright in extenuating circumstances, such as:

• Death of the CD holder: The beneficiary designated by the account holder will be able to receive funds without paying an early withdrawal penalty.
• Disability or legal incapacity of a CD owner: If a court has determined that a CD holder is incompetent, then he or she is exempt from early withdrawal penalties.
• Required minimum distributions from an IRA CD: An IRA CD operates in much the same way as any other CD plus the tax benefits you receive from an Individual Retirement Account (IRA). And like you would with any traditional IRA, the IRS requires owners to start collecting distributions by April after your 70½ birthday, so most banks waive any penalties. How much you draw depends on estimated life expectancy and the value of your account.

CDs that offer higher rates generally have longer terms and bigger early withdrawal penalties.

For those who need funds for expenses that may come up soon, it’s probably not a good idea to lock up all your savings in a CD for an extended period of time.

There are a few common strategies to avoid early withdrawal penalties:

• Opt for other deposit accounts: To avoid an early withdrawal penalty, stash money in a money market or high-yield savings account that doesn’t apply an early withdrawal penalty. Or, select a no-penalty CD.
• Build a CD “ladder”: Another common strategy to avoid that early withdrawal penalty is CD laddering. A CD ladder is a series of multiple CDs with varying terms. By laddering them, you may take advantage of higher rates while maintaining access to your funds.
  • Here is how it works: Invest funds in short-, medium – and long-term CDs that mature at different times. When you need cash, you can withdraw without penalty at maturity of the short-term CD. Or, if you don’t need it, reinvest the money to a longer-term CD to earn more interest.

Author’s Verdict

Now that you know all the information about CD accounts and early withdrawal penalty fees, you can decide if a CD account is for you and how to avoid the penalty fee.

If you are looking for a good CD account to open with a desirable rate, be sure to check out our list of Best CD Rates.

In addition, be sure to check out our list of Best Bank Promotions to find new bank bonuses and our list of Best Bank Rates for savings and money market account rates to maximize your money.