What to know about CD early-withdrawal penalties

When you want to save money in a safe place over a longer period, you generally have two main options: a savings account or a certificate of deposit account.

CDs usually offer higher interest rates in exchange for your commitment to keep your money in the account for a specified number of months, which is referred to as the “term.” At the end of the term, when the CD matures, you can withdraw the money you originally saved plus the interest it earned.  

But if you want to withdraw money before the CD matures, you could face a penalty. Let’s take a look at what a CD early-withdrawal penalty is, when you might face one and how to avoid getting penalized.

• What is a CD early-withdrawal penalty?
• How much can I withdraw early from a CD?
• How do I calculate my early-withdrawal penalty?
• When might the CD early-withdrawal penalty be worth paying?
• Next steps: How to avoid CD early-withdrawal penalties

What is a CD early-withdrawal penalty?

Opening a CD is like promising the bank or credit union that’s holding the account that you’ll leave the money there for the entire term of the CD. If you break that promise and withdraw some of the principal early, the financial institution may charge you a penalty.

The amount of the penalty can vary from bank to bank and depends on multiple factors. But it’s common for financial institutions to withhold a certain amount of interest on the money you withdraw as a penalty. Some financial institutions may also tack on an additional fee. And, if the early-withdrawal fee is more than the interest your CD earned by the time you made the withdrawal, the financial institution could take some of the principal to make up the shortfall.

Just how early is the withdrawal?

How long before the CD’s maturity date you make a withdrawal also matters.

If you withdraw the principal within the first six days after depositing the money in a CD, federal law mandates a minimum penalty of at least seven days of simple interest. But banks and credit unions can — and typically do — charge a higher penalty.

In addition to the penalty, you’ll also lose future interest earnings if you withdraw the entire principal. So depending on your bank’s early-withdrawal penalty and how soon before the maturity date you make the withdrawal, you could potentially lose all earnings for the CD.

For example, if you withdraw all of the principal from a six-month CD during month three of the term, and the bank charges a penalty equal to three months’ worth of interest, you’ll have lost all your earnings on the principal.

How long is the CD term?

Financial institutions often determine how much interest to withhold as a penalty based on the CD’s term. For example, if your CD has a one- to five-year term, a bank may charge you 180 days of interest on the amount of principal you withdraw. For a three-month CD, another bank may charge an early-withdrawal penalty of 90 days of interest on the amount you withdraw, but no more than the total interest you would have earned throughout the fixed term.

Typically, the longer the term, the more interest you’ll forgo. For example, some banks may charge a penalty of 12 months of interest on a 36-month-term CD. Others may just charge a set fee of $25 plus 3% of the amount withdrawn.

Since the penalty can vary by bank, it’s important to read your financial institution’s account agreement carefully before you open a CD.

How much can I withdraw early from a CD?

Whether you can withdraw all or only some of the principal from your CD will depend on your financial institution. Some banks don’t allow partial withdrawals of a CD’s principal.

It’s also important to remember that some CD accounts may automatically renew. In these cases, your bank will notify you and give you a certain time frame to make withdrawals, completely cash out or close the account. If you miss this window and the CD automatically renews, the early-withdrawal penalty will once again apply.

How do I calculate my early-withdrawal penalty?

First, check with your bank and look at your account agreement to determine what the bank’s penalty policy is. An online early-withdrawal calculator may also help you get a better idea of how your bank’s early-withdrawal penalty will affect your CD’s proceeds. You may need to enter information such as your bank’s name, your CD term, annual percentage yield and the penalty amount outlined in your account agreement (such as 12 months’ interest).

Depending on how your bank calculates interest, you can also use this standard formula to calculate your early-withdrawal penalty (for interest penalty calculated on a monthly basis).

Penalty = Amount withdrawn x (interest rate/12) x number of months’ interest

In this formula, 12 equates to 12 months in a year, since interest rates are typically calculated on an annualized basis. The number of months’ interest is equal to the number of months of interest you’d forgo by making an early withdrawal.

As an example, let’s say you have a one-year CD with a 1% interest rate and you want to withdraw $2,000 from your account. And there’s a withdrawal penalty of three months’ worth of interest. Your calculations would look like this.

$2,000 x (.01/12) x 3 = $5 penalty

In this scenario, your penalty would equal $5. But some banks may charge an additional minimum fee, such as $25, for an early withdrawal. If your bank did in this case, you’d have to pay the minimum fee plus $5 to withdraw from the account.

Image: mned_cdearly

When might the CD early-withdrawal penalty be worth paying?

Depending on the amount of the penalty and how much you need the cash you’ve put in the CD, you may decide it’s worth it to just pay the penalty so you can access your money. In the example above, paying either a $5 or $25 penalty may make sense to access $2,000 you can use to pay for an emergency home repair, or if you decide you’d rather put that money into a different investment account that offers a higher interest rate.

You may even decide you’d rather transfer this money to a high-yield savings account, which offers a higher interest rate on your deposits while giving you more flexibility to withdraw your savings.

Or maybe you need the money to pay off a high-interest-rate credit card, which is probably charging you much higher interest than what you actually earn on your deposits in a CD account. For example, if you’re only earning 1% interest on your CD account, but paying 23.99% interest on your credit card balance, the benefits of using the money to pay off your credit card balance may outweigh any early-withdrawal penalty you’ll incur.

As you decide whether to take the CD early-withdrawal penalty, consider whether you’re doing so based on a true financial need versus a financial “want.”  This may help you make the best financial decision for your situation.

Next steps: How to avoid CD early-withdrawal penalties

CD early-withdrawal penalties are largely avoidable, though emergencies can happen that may force you to withdraw money and take the hit. Consider these options before taking the penalty.

• Wait until the CD matures. Take advantage of the grace period after your CD term ends to make withdrawals without penalty or to completely cash out your account. Details about the grace period should be included in your account agreement, but it’s also a good idea to call your bank and confirm when this period begins and how long it lasts.
• Look for no-penalty CDs. Also known as a liquid CD account, a no-penalty CD allows you to withdraw money from this account without penalty. The rules around this vary by bank, but you can often make withdrawals within seven days of your original deposit, after a set time period or throughout the entire term based on what’s outlined in your account agreement. The trade-off is that these accounts may offer lower interest rates than traditional CDs. Some may also require a higher minimum deposit to open the account. Still, this may be a worthwhile option if you’re looking for more flexibility and to avoid penalties.
• Set up a CD ladder. A CD ladder allows you to divide your savings across several CD accounts with different terms and interest rates. For example, you could deposit $2,000 into a 12-month CD at a set interest rate, another $2,000 into a 24-month CD at a slightly higher interest rate and another $2,000 into a five-year CD at an even higher interest rate (generally, the longer the term, the higher the interest rate). With this strategy, you can access some of your money earlier without incurring a penalty if you don’t make withdrawals before the end of the term. 

CD accounts are great savings vehicles if you want to keep your money in a safe place and earn interest on your savings. But you have to sacrifice some flexibility in return for these benefits. If you already have a solid emergency fund and are making maximum contributions to your retirement savings, a CD account may be a good option, since you may not be as tempted to withdraw the money if you experience a financial emergency.

Before you open a CD, consider your short-term and long-term financial goals and make sure you understand all the potential penalties and fees associated with CD early withdrawals. Taking these steps beforehand could ensure you maximize the interest you earn by using this type of account.