What Is a CD Early Withdrawal Penalty?

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.

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

For example, 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

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 CDs

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.

Contact O1ne Mortgage for Your Mortgage Needs

At O1ne Mortgage, we understand the importance of making informed financial decisions. Whether you’re looking to invest in a CD or need assistance with mortgage services, our team of experts is here to help. Call us today at 213-732-3074 for any mortgage service needs. Let us help you achieve your financial goals with confidence.