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When you invest in a certificate of deposit (CD), you agree to leave your money in the account for a certain length of time. Once that term ends, you receive your money plus interest. If you withdraw funds from your CD before the maturity date, you may have to pay an early withdrawal penalty. The penalty you pay can vary among financial institutions, but there may be ways to avoid paying this penalty altogether.
What Is a CD Early Withdrawal Penalty?
Certificates of deposit (CDs) are low-risk savings accounts for people who want to earn a higher interest rate than they'd get on a traditional savings account—and who can let their money sit for a period of time. Unlike money market and high-yield savings accounts, CDs are time-based accounts that require you to keep your money in the account for a set period of time, usually a few months to several years. Cashing out before your CD matures often means paying a penalty.
Banks and credit unions calculate CD early withdrawal penalties based on the amount of interest the CD would earn over a certain time period. Federal law stipulates minimum penalties for early CD withdrawal: If you withdraw money within the first six days after making the initial deposit, the early withdrawal penalty is worth at least seven days of interest. Federal law doesn't have a required maximum penalty, so your fee may be higher depending on the terms in your account.
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How to Calculate an Early Withdrawal Penalty for a CD
You may be considering an early CD withdrawal if interest rates are substantially higher now than when you first opened your account. Maybe you think you can earn a higher return on your investment (ROI) if you invest the money in a high-yield savings account, money market account or other investment.
Calculating what it will cost to withdraw your money before the CD maturity date can help you decide whether it's worth it. First, understand your bank's CD terms and how it treats early CD withdrawals. You'll need to know:
- The penalty for your CD term
- How your interest compounds (daily or monthly)
- Whether the bank bases your penalty on the entire balance or just on the amount you withdraw
Once you have that information, calculate your penalty using this formula:
Penalty = Withdrawal Amount (or Balance Amount) × (Interest Rate/365 Days) × Number of Days' Interest
Say you have $10,000 in a five-year CD with a 5% annual percentage yield (APY). Your bank charges a penalty of 150 days' worth of interest for early withdrawal and requires you to withdraw the entire balance. In this case, your penalty will be just over $205.
$10,000 × (.05/365) × 150 = $205.48
| CD Early Withdrawal Penalties | |||
|---|---|---|---|
| Bank or Financial Institution | 1-year CD | 3-year CD | 5-year CD |
| Ally | 60 days of interest | 90 days of interest | 150 days of interest |
| American Express | 270 days of interest | 270 days of interest | 540 days of interest |
| Citibank | 90 days of interest | 180 days of interest | 180 days of interest |
| Capital One 360 | 3 months of interest | 6 months of interest | 6 months of interest |
| Wells Fargo | 3 months of interest | 12 months of interest | 12 months of interest |
How to Avoid CD Early Withdrawal Penalties
The best way to avoid an early withdrawal penalty is to keep your money in the CD until it matures. Other options may include:
No-Penalty CDs
No-penalty CDs may allow you to withdraw money without paying a penalty about a week after you make your initial deposit. The trade-off is the interest rate may be lower than with other CDs, although this can vary. But unlike most savings accounts, your rate is fixed and you may or may not need to keep a minimum balance in your account.
Brokered CD
Brokered CDs are sold through a third party, usually a brokerage firm. Brokered CDs may offer longer terms and higher interest rates than CDs purchased at a bank. They also typically have no early withdrawal penalties. If you need your money before the term ends, you may be able to sell your CD on the secondary market instead of paying a fee to the bank.
CD Laddering
With CD laddering, you buy multiple CDs at varying terms. So, instead of buying one CD worth $9,000, you buy three for $3,000—one with a six-month term, one for a 12-month term and one for an 18-month term. This way, one-third of your money is available or liquid every six months without penalty of early withdrawal.
CD Barbell
With a CD barbell, you invest half your money in a short-term CD and half into a long-term CD. This gives you the flexibility to access half of your investment at the end of the term without penalty. Plus, you also reap the benefit of higher interest in a longer-term account.
Are CD Early Withdrawal Penalties Tax-Deductible?
Generally, you will likely pay an early withdrawal penalty when you withdraw money from a standard CD before the maturity date. You can deduct the amount you withdraw from your penalty, which may offset how much you pay in taxes on any interest earned, according to the IRS.
So, if you earned $70 in interest, but you paid an early withdrawal penalty of $30, the full $30 can be deducted on taxes. Any early withdrawal penalties are included in Box 2 on the 1099-INT form from your bank or other financial institution, labeled "early withdrawal penalty."
It's a Matter of Time
Most people invest in CDs planning to keep their money safely stashed away until the term is over and it matures. However, plans change and sometimes you need access to your money early. If that happens, you may pay an early withdrawal penalty. Instead, consider building an emergency or sinking fund or using money in a high-yield savings account to help cover any costs related to a financial setback.
Then, make sure your credit is in top shape so you have other options to fall back on. Get your free credit score and credit report from Experian to monitor your credit and see the same information lenders see when requesting your credit.