Certificate of deposit accounts lock in your money for a certain period and guarantee an interest rate. But sometimes, life happens in the middle of the CD’s term. You have a dental emergency, your car needs new tires, or (yes, please!) a friend offers you a once-in-a-lifetime opportunity to join a trip to Barcelona but you just don’t have cash on hand to afford it. In these and other situations, you may be tempted to crack into a CD.
Should you do so, however, you will likely have to pay an early withdrawal penalty since you aren’t sticking with the agreed-to maturity term (the amount of time the CD was set for). You might forfeit some or all of the interest earned as a result. Read on to learn more about early withdrawal penalties for CDs and how to avoid them.
What Is a CD Early Withdrawal Penalty?
First, what is a CD? In simple terms, it’s an FDIC-insured time deposit. When you open a certificate of deposit account, you’re depositing money for a specific time frame. Depending on the CD, this may be as little as 30 days or as long as 10 years.
As the CD matures, your balance can earn interest. Generally, the longer the term, the higher the interest rate and APY. However, if you take money out before the maturity date, the bank can charge a CD withdrawal penalty.
Federal law sets the minimum penalty for early CD withdrawal at seven days’ interest if you withdraw money within the first six days after deposit. Banks can set the maximum CD withdrawal penalty higher.
The amount you might pay for withdrawing money from a CD early can depend on several factors, including:
• Maturity term of the CD
• How long the CD was open before you made the withdrawal
• The amount of the initial deposit and the amount that’s withdrawn.
Your bank may or may not allow you to make a partial early CD withdrawal. If you’re not able to withdraw a partial amount, you might have to cash out the whole CD which could result in a larger penalty.
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How to Calculate an Early Withdrawal Penalty for a CD
You’re probably wondering just how steep a penalty you’d have to pay for early CD withdrawal. Are we talking $5 or 5% of the money invested? More?
Banks are required to provide you with certain disclosures regarding your accounts, including CD accounts. So the first step in calculating what you might pay for a CD early withdrawal penalty is to review your bank’s policy.
Again, this can vary depending on the bank. So, for example, here’s what a few banks charge if you make an early withdrawal from CD accounts. All penalties are deducted from the CD’s principal.
| CD Term | CD Early Withdrawal Penalty |
|---|---|
| 1 year | • 180 days’ interest • 3 months’ interest • Half of interest the money would have earned over entire term or 1% of the amount withdrawn, whichever is greater, plus $25 |
| 3 years | • 180 days’ interest • 6 months’ interest • Half of interest the money would have earned over entire term or 3% of the amount withdrawn, whichever is greater, plus $25 |
You should be able to find this information readily available on your bank’s website. But if not, you can contact your bank or visit a branch to get more details on the penalties for early withdrawal from a CD. In addition to telling you what the penalty is, the bank should also be able to tell you how the penalty is calculated.
Banks may calculate the penalty for early CD withdrawal based on:
• The amount withdrawn
• The entire balance
• Daily interest or monthly interest.
Calculating a CD Early WIthdrawal Penalty
Want to get a little more granular? Let’s dive into a little basic math to show you how the numbers look. Using Chase as an example, we see that the bank uses the amount withdrawn as the basis for calculating CD early withdrawal penalties. The calculation uses daily rather than monthly interest.
So the formula for calculating the penalty you might pay for an early CD withdrawal would look like this:
Penalty = Amount withdrawn x (Interest rate/365) x number of days’ interest.
So, say you have a 12-month CD that’s earning a 5% APY. You withdraw your initial $5,000 deposit six months prior to the CD’s maturity date. The math would look like this:
$5,000 x (0.05/365) x 180 = $123.29
You could also use an online CD early-withdrawal penalty calculator to figure out how much interest you might forfeit if you decide to withdraw money from a CD ahead of schedule.
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Ways to Avoid Early Withdrawal Penalties for a CD
There are some options for avoiding prepayment penalties associated with early CD withdrawals. The strategies you could try include:
• Withdrawing only the interest earned. Your bank may allow you to withdraw the interest earned on a CD without assessing a penalty. This assumes that you don’t touch the principal amount at all. This could be an attractive option if you need some quick cash but don’t necessarily need or want to withdraw your initial deposit.
• Requesting a waiver of the penalty due to a crisis. If you are really in a bind, your bank may honor this.
• Tapping your rainy-day money instead, but this should really only be done if you have the right reason to using your emergency fund.
• Opening a no-penalty CD account. Banks can offer CDs that don’t charge a penalty for early CD withdrawal. The trade-off is that no-penalty CDs may offer a lower interest rate and APY, so you’d have to consider whether the convenience afforded by no-penalty CDs outweighs earning a higher rate.
• Building a CD ladder. A CD ladder is a collection of CD accounts, each with varying maturity terms. So you might have five CDs with maturity dates spaced six months apart. The idea is that you can avoid early withdrawal penalties because your next maturity date is always on the horizon.
• Consider a CD-secured loan. You may find some lenders who offer a CD-secured loan, but review the terms carefully and be sure you can make the payments at a time when money is tight.
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When to Withdraw CDs Early
Withdrawing money from a CD early, even if it means triggering an early CD withdrawal penalty, could make sense in some situations. Some examples:
• If you have an emergency situation with no other cash reserves to rely on and you want to avoid using credit, it may be the best (or only move). For example, say your car breaks down and you need $5,000 to fix it, but you only have $1,200 in your emergency fund. Then paying a CD withdrawal penalty could be worth it. This move would allow you to avoid having to charge the expense on a high-interest credit card or take out a loan.
• Paying a penalty for early CD withdrawal could be worthwhile if your interest rate is low. You could access the funds and, with what you don’t use up, roll the money into a new CD with a higher APY. You’d have to calculate the amount of the penalty for withdrawing money early and compare that to the interest you could earn with a new CD to decide if it’s worth it or not.
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The Takeaway
Investing in CDs can make sense if you want a safe way to earn interest on money you don’t necessarily need for the near-term. But sometimes, you’ll feel you must withdraw money early from a CD, despite the fact that you locked in for a specific term and interest rate. When doing so, you’ll face penalties, which may or may not make this transaction worth it to you. You can also follow a couple of smart money strategies to make sure you avoid triggering early CD withdrawal penalties in the future, because who wants to pay fees unless you absolutely have to?
If you hate penalties and fees, it can be wise to consider all your possibilities in terms of where to keep your money.
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FAQ
What happens if I take money out of a CD early?
If you withdraw money from a CD early, you will likely be assessed a penalty, which is often all or some of the interest earned, and possibly a fee.
Can I write off a CD early withdrawal penalty?
If you wind up paying an early withdrawal penalty, you can deduct the amount from your taxes, even if it’s greater than the interest earned.
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