CD Early Withdrawal Penalty: What You Should Know

Certificates of deposit (CDs) can be an excellent savings vehicle for anyone who wants stability and guaranteed growth. These low-risk investments offer the protection of the Federal Deposit Insurance Corporation (FDIC) and a higher interest rate than you generally can find with savings or money market accounts.

There’s one thing to be aware of: early withdrawal penalties. Banks and credit unions often charge a fee if you withdraw money before maturity. Understanding how early withdrawal penalties work is essential when deciding if a CD is right for you.

CD Basics

A CD is a type of time deposit account. When you open a CD, you agree to keep your money on deposit with the bank for a certain term. Minimum deposits for CDs can range from $0 to $10,000 or more. And banks offer CDs with terms ranging from 28 days to 10 or more years. Credit unions also offer CDs, though they’re typically called “share certificates.”

In exchange for keeping your money in the CD, the institution pays interest on your deposit. The interest rate you earn depends on the institution and the term. Typically, the longer the term, the higher the interest rate. Interest compounds often daily or monthly, depending on your bank or credit union.

Once the CD matures, meaning it reaches the end of its term, banks and credits may offer a few options:

• Renew your CD at the same rate and term
• Roll your original deposit and the interest earned into a new CD
• Withdraw your original deposit and the interest earned

Institutions want to discourage CD holders from withdrawing money before the maturity date, since the financial institution counts on both your principal and its growth. When the bank knows how long it can use your money, it can keep its costs low.

Withdraw your money before the maturity date and it could expose the bank to financial penalties on the money it has invested or loaned out. This is why, in most cases, you’ll pay a CD early withdrawal penalty for taking money out before maturity.

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CD Charges

CDs typically don’t have any type of monthly maintenance fee. You may pay no fees at all for a CD unless you’re withdrawing money from the account ahead of the maturity date.

Understanding Early Withdrawal Penalties

Early withdrawal penalties for CDs vary by financial institution. CD early withdrawal penalties are typically calculated as a set period’s worth of interest. For instance, you may see the penalty listed as “90 days of interest” or “12 months’ interest.” The amount of interest you forfeit can depend on the CD term and how long the CD has been open.

Many banks calculate your penalty as a number of days’ simple interest at the rate currently in effect on the CD. That means the early withdrawal penalty doesn’t factor in the compounding of interest over time. Instead, you pay the straight interest over that time. However, there is no cap on early withdrawal penalties imposed by the federal government, which is why it’s worth reading the fine print on your CD information.

Unfortunately, even though banks and credit unions define penalties in terms of interest, your principal isn’t necessarily safe. If your accrued interest is less than the penalty’s total amount, your financial institution may take the difference from your principal.

How To Calculate Early Withdrawal Penalty for a CD

Calculating the early withdrawal penalty for a CD can depend on several factors::

• The withdrawal penalty your financial institution assesses
• Whether the penalty is calculated on a monthly or daily basis
• If the penalty is assessed on your total balance or only the amount of your withdrawal

For example, let’s say you have $10,000 in a 5-year CD earning an interest rate of 1.00%. The early withdrawal penalty for a 5-year CD at this institution is 150 days’ interest, and you’re not allowed partial early withdrawal, so you will have to take out the full amount. Here’s how you would calculate your withdrawal penalty:

Penalty = Account Balance x (Interest Rate/365 Days) x Number of Days’ Interest

Penalty = $10,000 x (0.01/365) x 150 Days’ Interest = $41.10

Let’s say in the scenario above you face an early withdrawal penalty of 18 months’ interest. Here is how you would calculate your penalty:

Penalty = Amount Withdrawn x (Interest Rate/12 Months) x Number of Months’ Interest

Penalty = $10,000 x (0.01/12) x 18 Months = $150

Check to see if your bank has a minimum early withdrawal penalty. In many cases, your financial institution will require a minimum penalty, such as $25, if the total calculated penalty is below that threshold.

Penalties at Major Banks

It’s essential to understand how the biggest banks levy early withdrawal penalties on CDs. While many banks charge penalties using simple interest, some do not specify whether their penalty is simple or compound.

Here’s an overview of CD early withdrawal penalties at some of the top banks:

Avoiding CD Early Withdrawal Penalties

Although early withdrawal penalties are common with CDs, there are ways to avoid paying them.

Look for Flexible Early Withdrawal Policies

You may be able to withdraw a partial amount or the full amount from a CD before its maturity date, depending on your institution’s early withdrawal policies. For example, some CDs will allow you to access some or all of the interest you have earned without touching the principal.

In some cases, you will specify when you open the CD whether you would prefer the interest to compound within the CD or receive the interest paid to you in regular disbursements. The downside of choosing interest disbursements is that the interest will not compound, and you will only earn simple interest on your principal. But you do get some flexibility with this type of arrangement.

Even if your interest compounds, you may still be able to access your earned interest without paying an early withdrawal penalty. Each bank has its own rules about accessing your accrued interest, so it’s worth looking into what your institution allows.

Keep in mind that while some banks will not allow CD owners to make a partial early withdrawal, others do permit these types of withdrawals. If your financial institution allows for partial early withdrawals, you will only owe interest on the portion you withdraw, and you can leave the balance invested in the CD.

Invest in a No-Penalty CD

A no-penalty CD is another option for consumers who want the benefits of a CD with the flexibility to access their money at any time. These CDs allow account holders to withdraw their money penalty-free at any time. For example, a bank may allow you can take an early withdrawal after the first six days of funding the CD with no penalty.

The downside to no-penalty CDs is their APY, often less than their traditional CD counterparts. Also, you may not be able to make partial withdrawals from a no-penalty CD. If you need some money, you may have to take out your entire principal, plus whatever interest you have earned, and close the account.

However, even with these downsides, no-penalty CDs may offer a better APY than savings accounts, and your interest rate is guaranteed. If you need flexibility, a no-penalty CD may be a great option.

Create a CD Ladder

CD ladders offer a way to get the best of these vehicles while maintaining your flexibility. To create a CD ladder, you will open several CDs, each with different maturity dates, rather than putting all of your investment into a single CD.

For instance, let’s say you have $5,000 total that you would like to put into CDs. Your ladder may look like this:

• $1,000 in a six-month CD
• $1,000 in a 12-month
• $1,000 in an 18-month
• $1,000 in a 24-month
• $1,000 in a 36-month

As each rung of the CD ladder matures, you can then choose to roll the money over into another CD or withdraw it.

While having a CD ladder can’t protect you from the kind of sudden financial emergencies that may prompt you to make an early withdrawal, it still can help you minimize penalties. If you keep your ladder’s maturity dates relatively close together, you’ll know that you don’t have to wait for more than a few months for the next CD to mature. If your financial need can wait until the next maturity date, you won’t trigger a penalty for early withdrawal.

Even if you break one of the CDs in your ladder, you’ll only pay the penalty on that single CD, meaning the majority of your investment will still enjoy compounding interest with no penalties.

Other Circumstances

Many banks will waive the penalty entirely in case of the account holder’s death, disability or legal incompetence. This rule helps any family in need of money in the wake of their loved one’s death or incapacitating incident.

When It’s Worth It to Pay the Penalty

Although having to give up interest (and potentially some principal) is never ideal, there are two situations in which making an early withdrawal from your CD may be the best option.

The first is when you face a genuine financial emergency, and breaking your CD is the cheapest option for weathering the storm. Suppose the amount you will pay for an early withdrawal penalty is lower than what you’d pay in credit card interest, personal loan interest or tax penalties if you’re borrowing from an IRA. In that case, it could be smarter to take the hit to your CD rather than other parts of your financial life.

Another reason CD holders consider making an early withdrawal is to take advantage of improved interest rates. The big benefit of CDs—the fixed APY—also can be a significant drawback if interest rates trend upward after you have purchased your CD. When the difference between your CD’s locked-in interest rate and the rates offered by new CDs seems vast, it can be very tempting to break your CD to reinvest the money into one with a higher rate.

If interest rates have gone up significantly since you purchased your CD, taking the early withdrawal penalty may be worthwhile. To decide whether to take the early withdrawal penalty, crunch the numbers. Start by calculating how many months of interest you will be giving up by breaking the CD. That’s the number you will have to beat.

Then calculate how much interest you will earn with the higher-paying CD in the time between opening it and the original CD’s maturity date. If this number is lower than your penalty, keep your money where it is. If it’s higher, it makes sense to break your current CD to take advantage of the higher rates with another CD.

Don’t Tie Up Money You Can’t Afford

CDs can be an important part of your savings plan. But it’s also important not to tie up money in CDs that you may need to access.

This means paying attention to the fine print on everything about your CD purchases, from interest rates to penalties. It also means using savvy strategies, such as CD laddering, to help ensure you get the most out of this saving vehicle’s stability and interest, while maintaining some flexibility.

Opening a high yield savings account or money market account is another smart move that can help you avoid CD early withdrawal penalties. By keeping some of your savings in a highly liquid and accessible account, you reduce the odds of needing to break into a CD early if a financial emergency arises.

The Bottom Line

Taking an early withdrawal from a CD is seldom ideal. Not only does it leave you vulnerable to your financial institution’s early withdrawal penalty, but it also means potentially losing out on compounding growth. But if you need to access money from your CD before the maturity date, understanding what to expect from the early withdrawal penalty can help you make the best decision for yourself and your money.

Frequently Asked Questions (FAQs)