This post may contain affiliate links which may compensate us based on your interaction. Please read the disclosures for more information.
Certificates of deposit (CDs) pay high interest, but come with one potential pitfall. Keep reading to learn about early withdrawal penalties.
Image source: Getty Images
Right now is an especially good time to have money in the bank. Thanks to the veritable flood of Federal Reserve rate hikes, many banks have raised their own APYs on savings accounts, money market accounts, and CDs.
A certificate of deposit, or CD, is a special type of savings account that pays a higher rate of interest in exchange for you agreeing to keep your money in the account for a certain period of time. CDs benefit from FDIC insurance, making them very safe. CD terms vary, but you can find terms lasting from a couple of months up to as many as 10 years. When the term is up, you can withdraw your money (now made richer by a certain percentage; the best CD rates right now are 5.00% APY or better) and do whatever you want with it, including rolling it into a new CD account.
But what if something comes up and you need the money in your CD account — and the term’s not up yet? Therein lies a potential problem with CDs: Early withdrawal penalties.
How do early withdrawal penalties work?
If you need to take the money out of your CD account early, you won’t be allowed to withdraw just a part of it — rather, if you’ve got $5,000 in the account, that’s what you’ll be taking out. And unfortunately, you’ll also lose some or all of the interest you’ve earned on it, depending on how long your term was and how early you ended it.
How much interest you’ll forfeit depends on the terms of your account and the bank that holds it. I took a look at a few of our favorite CDs and found examples of early withdrawal penalties ranging from up to three months to 180 days of simple interest. So be sure to read the fine print on your CD account so you’ll know how much you’re risking if you withdraw early.
It’s important to note that no-penalty CDs do exist, but the rates are generally less than what you’ll get with a traditional CD. And this makes sense, as banks are more willing to pay a higher APY to consumers willing to leave their money alone for a set term knowing they’ll be charged a penalty if they don’t.
Consider these other options to avoid penalties
Thankfully, if you have a chunk of money you want to keep in a bank account (rather than exposing it to the short-term volatility of the stock market), you have other options for accounts. And these don’t work the same way as CDs — you won’t be locking your money up for a set term and can generally withdraw whenever you want (within certain limits; more on that below).
A regular savings account doesn’t pay enough interest to make one worthwhile if you’re hoping to grow your money (as of this writing, the average rate on savings accounts overall is just 0.43% APY). But a high-yield savings account is a very attractive prospect these days. In fact, you could earn around the same APY (5.00%) with one of these accounts as you might with a CD, and you won’t have to lock your money up, either. Look to online banks for the best high-yield savings accounts.
A money market account is also a great place for your money, and it comes with easier access than a savings account — many money market accounts have check-writing capabilities or even come with a debit card. These, too, have been favorably impacted by Federal Reserve rate hikes and are paying comparably to CDs and high-yield savings accounts.
One caveat for savings and money market accounts
It’s important to note, however, that just because you’re not locking your money up for a period with these accounts doesn’t mean you have unfettered access to it. Many banks still enforce pre-pandemic limits imposed by Regulation D. This limits you to six or fewer convenient withdrawals from these accounts every month.
If you have money you’re actively spending, a checking account is the best place for it. CDs, savings accounts, and money market accounts are much better for keeping your money safe and reasonably accessible, and growing it with interest, rather than having it available to spend readily.
CDs can be a great part of a larger financial and savings strategy, and with rates as high as they are right now, they’re certainly worth considering. Just remember to read the fine print and learn what early withdrawal penalty you’ll face, just in case you have to end your CD term early.
These savings accounts are FDIC insured and could earn you 12x your bank
Many people are missing out on guaranteed returns as their money languishes in a big bank savings account earning next to no interest. Our picks of the best online savings accounts can earn you 12x the national average savings account rate. Click here to uncover the best-in-class picks that landed a spot on our shortlist of the best savings accounts for 2023.
We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.
