Certificates of Deposits (CDs) are recognized - and valued - as low-risk savings vehicles. But, like all financial products, they carry some degree of risk. As you consider and manage your CD accounts, there are several factors that you should keep in mind.
The Good News about CD Risk: There's Not Much of it. CD Risks are very limited, but worth considering:
- Early withdrawal penalties if you need to take money out of your CD account before the maturity date. Those penalties vary from bank to bank, but there is no legal maximum on them, so the risk on this front varies widely. That's why it's important to know - upfront - what your bank's penalties are. Perhaps most important, make sure you understand how long you can do without the money you want to put into a CD account, and then pick the term that works for you. At Ally Bank, the early withdrawal penalty on CDs is equivalent to just 60 days' interest, and if you make an early withdrawal on the 11-month No Penalty CD, you pay no penalty as long as you make the withdrawal after the first six days of when you fund your account.
- Tax liabilities - "Interest on a CD account...is probably taxable at the individual's normal tax rate. The lower dividend and/or capital gains rates may not apply," Andy Tilp, president of Trillium Valley Financial Planning in Sherwood, Oregon, told Ally Bank.
- Reinvestment risk - the concern that, if interest rates go down and your existing CD account with relatively high interest matures, you may have to roll over the CD at the lower rate.
- Inflation risk - the possibility that over the long run, inflation will outpace your CD account's interest earnings. To some extent, inflation risk may be addressed by "laddering" CD accounts. This means setting up several CDs with staggered maturity dates, so that you can open new CDs regularly.
- Risk from the limits of FDIC insurance - "It's important to remember that whatever the [FDIC insurance] limit is for your particular account and registration, the limit is for that financial institution - it's not per CD," Jim Heitman, founder/owner of Compass Financial Planning in Alta Loma, California, told Ally Bank in a recent interview. Of course, it is unlikely that you would ever need that insurance, but it's good to be aware of the potential risk as well as all the ways you can maximize your FDIC insurance limits.
The Best News about CD Risk: It's Easily Managed. These risks can be easily managed, and on the rewards side of the ledger, CD accounts often balance them out. They pay interest, usually at a higher rate than regular savings accounts. And they provide predictability that lets you plan ahead with a level of safety that can give you peace of mind.
Learn more about the full line of Ally Bank CDs at AllyBank.com or call live, 24/7 support at 877-247-ALLY (2559) today.
Other articles in the Understanding CDs series:Understanding CDs: An Introduction (Part 1 of 3)Understanding Certificates of Deposit: The Growing Variety (Part 2 of 3)