How To Avoid A CD Early Withdrawal Penalty

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Many savers seek out certificates of deposit (CDs) thanks to their considerable benefits, which may include a high yield and a guaranteed rate of return. Unlike riskier investments, the money in your CD will grow predictably over time — allowing you to know exactly how much interest your money will have earned when the CD matures.

In exchange for these benefits, CDs usually require you to lock in your money for a set term — otherwise subjecting yourself to an early withdrawal penalty. As such, keeping the money in the CD until it matures is key to being able to earn the full amount of interest.

Ways to avoid a CD early withdrawal penalty

Withdrawing your money from a CD before the term ends can be costly since you’ll lose some interest and possibly even some of your principal, depending on how early into the term you make the withdrawal.

Consider some of these ways to help ensure you won’t end up needing to access the money early and be forced to pay a penalty.

Have a liquid emergency fund

Before locking your money into a CD, it’s important to have a separate emergency fund that you can tap into when unplanned expenses hit. This may help you avoid needing to pull your money out of a CD early. The amount to keep in an emergency fund should be able to cover at least three to six months’ worth of living expenses. The best place for such a fund is often a liquid savings account since it allows you to access your money easily at any time without paying a penalty.

Shop around for a savings account with the best annual percentage yield (APY), which often can be found in high-yield savings accounts from online banks. Some of these high-yield accounts currently pay more than 4 percent APY.

Choose a no-penalty CD

A no-penalty CD still pays you a guaranteed rate but allows you to withdraw the money early without being penalized. Such a CD comes in handy if you find yourself in need of money for a financial emergency. It also affords the flexibility to switch to a different CD or another type of deposit account if rates rise significantly. The price you’ll pay for the convenience that comes with a no-penalty CD, however, is they often pay lower yields than traditional CDs.

Consider a CD ladder

A CD ladder strategy consists of opening multiple CDs of varying terms, so you can reap the higher rates that often come with longer terms while ensuring access to some of your funds sooner through the shorter terms. Having one or more CDs with terms of 12 months or less, for instance, means their principal and interest can be back in your hands in the relatively near future — which you may feel reduces the chance of needing to pull your money out early.

How much is the early withdrawal penalty for a CD? What banks charge

Typically, CD terms range from three months to 10 years. The penalty imposed by a bank for withdrawing the money before the CD matures often depends on the length of a given term. In general, the longer the term, the bigger the penalty you’ll pay. Here are some examples of what various banks charge for early withdrawal from CDs with terms of five years, three years and one year:

What are good alternatives to CDs?

Savers who want to earn a stable return on their funds without needing to lock them in for a set term have various other options to consider:

• Liquid savings accounts: As we’ve mentioned, a liquid savings account earns interest and provides easy access to your funds. Unlike CDs, savings accounts carry a variable APY, which can make them especially attractive in a rising-rate environment. Like many CDs, savings accounts are often insured by the Federal Deposit Insurance Corporation (FDIC) if your bank is insured, so your funds are protected in the event of a bank failure.
• Money market accounts: Like savings accounts, a money market account is a liquid asset that earns interest, yet it may offer checking account features such as a debit card and the ability to write checks. Money markets pay a predictable yield and are often federally insured.
• Money market funds: Regulated by the Securities and Exchange Commission, money market funds are low-risk investments that can pay a higher yield than traditional bank savings accounts. Also referred to as money market mutual funds, they’re commonly offered by banks, mutual fund companies and brokerages firms.
• Short-term corporate bond funds: Bond funds are highly liquid pooled investments that can be bought or sold any day the markets are open for trading. Note that they’re not insured by the federal government, so it is possible to lose some or all of your money. Overall, they’re considered to be fairly low-risk investments, however.

  When could paying an early withdrawal penalty for a CD be worth it?
  

  Sometimes, taking the hit of an early withdrawal penalty can pay off in the long run, such as when rising rates make other saving and investing vehicles more lucrative.

  A recent research paper from professors at the University of Delaware and UCLA Anderson School of Management showed just how advantageous it can sometimes be to ditch a short-term CD for a longer one. The researchers analyzed CD offerings at nearly 17,000 bank branches and banks from 2001 through mid-2023 and found that, even after paying a penalty for early withdrawal from a CD, customers on average would take home more interest by putting their money in the longer CD than the shorter one with a lower yield.

Bottom line

CDs may allow you to reap the benefits of a competitive, guaranteed yield if you’re willing and able to lock your money in for a set term. Leaving your money in a CD for the full term is vital for earning the full amount of interest — though sometimes it can make sense to pay an early-withdrawal penalty if your money can yield enough elsewhere to not only recoup the loss but also earn more in interest. Having an emergency savings account can help you avoid making early CD withdrawals, and a no-penalty CD can be a viable alternative for anyone who may need access to the funds before the term expires.