Have a specific goal you’re saving toward? Opening a certificate of deposit (CD) account could make sense. But keep in mind: While savings accounts or money market accounts might allow you to make up to 10 withdrawals per month, CDs don't work the same way. Knowing when you might be subject to a CD early withdrawal penalty — and what it could cost you — can help you decide which savings strategy is right for your goals.
Read more: Take our quiz to find the best CD for you
What is a CD early withdrawal penalty?
When you open a CD, you enter a contract with the bank. Early withdrawal penalties are the consequence of breaking that agreement.
How are penalties calculated?
Banks can assess CD early withdrawal penalties as a percentage of the interest earned or as a flat fee. It's not uncommon for banks to use a structure that looks something like this:
CD term | Early withdrawal |
|---|---|
12 months | 60 days of interest |
36 months | 90 days of interest |
60 months | 150 days of interest |
Some banks may assess even steeper penalties. For example, with some, you might forfeit 180 days of interest for making an early withdrawal from a one-year CD and an entire year of interest for early withdrawals from a five-year CD. Here's how the numbers add up, assuming a $5,000 deposit and a 4.25% annual percentage yield (APY).
CD term | Early withdrawal penalty | Penalty |
|---|---|---|
12 months | 90 days of interest | $53.13 |
36 months | 180 days of interest | $106.25 |
60 months | 365 days of interest | $212.50 |
As you can see, the longer the term, the steeper the penalty ends up being. Use our CD early withdrawal penalty calculator to see what penalties you may incur for withdrawing early:
Potential reasons for early withdrawal
Pulling money out of a CD early, despite paying a penalty, might make sense if you find yourself in one of these situations:
Emergency expenses: A job loss, unexpected illness or major home repair could all prompt a need for cash, especially if you don't have an emergency fund to cover them.
Higher interest rates: Rising interest rates mean greater earnings on your savings. You might consider breaking a CD to re-deposit the funds into a new CD if the interest you could earn outweighs the penalty you might pay.
Making a big purchase: Withdrawing money from a CD early could make sense if you've been planning a large purchase that you're now ready to make, such as a down payment for a home.
How to avoid CD early withdrawal penalties
While CD early withdrawal penalties can be a drain on your interest earnings, you have options to help avoid them.
Create a CD ladder
The idea is to space out CD terms so that you always have a maturity date on the horizon. For example, you might purchase a three-month CD, a nine-month CD, a 12-month CD and a 24-month CD.
Read more about CD laddering strategies
Open a no-penalty CD
While no-penalty CDs tend to earn a lower APY than other CDs, you can withdraw money without a fee at any time during the maturity term. For example, with an Ally Bank No-Penalty CD you can withdraw money (the full balance has to be withdrawn) at any time after the first six days following account opening. You get to keep all the interest earned up to that point.
Utilize the grace period
Banks typically allow a 10-day grace period following maturity when you can withdraw money without a penalty, renew the CD or move your funds to a different account. If you do nothing during this time, your CD could automatically renew for the same term at the current interest rate for that term.
Is paying the penalty worth it?
If the benefits outweigh the penalty, it can be. Ultimately, it depends on your individual financial situation (you’ll want to do the math to ensure you make the right decision for you).
Select the right savings vehicle
CDs can be an effective way to save money, but it's important to keep early withdrawal penalties in mind. Parking all your savings in CDs might not be the right move if you don’t have a solid emergency fund, or a large upcoming expense, because early withdrawal penalties could trigger higher costs for you. Be sure to consider your short- and long-term financial needs before choosing the right option for you.
