How to Calculate and Avoid CD Early Withdrawal Penalties

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Understanding CD Early Withdrawal Penalties

When you invest in a certificate of deposit (CD), you agree to leave your money in the account for a specified period. Once that term ends, you receive your money plus interest. However, if you withdraw funds from your CD before the maturity date, you may incur an early withdrawal penalty. The penalty can vary among financial institutions, but there are ways to avoid paying it altogether.

What Is a CD Early Withdrawal Penalty?

Certificates of deposit (CDs) are low-risk savings accounts designed for individuals who want to earn a higher interest rate than a traditional savings account and can leave their money untouched for a set period. Unlike money market and high-yield savings accounts, CDs require you to keep your money in the account for a specific term, usually ranging from a few months to several years. Withdrawing funds before your CD matures often results in a penalty.

Banks and credit unions calculate CD early withdrawal penalties based on the interest the CD would earn over a certain 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 penalty is at least seven days of interest. There is no required maximum penalty, so your fee may be higher depending on your account terms.

How to Calculate an Early Withdrawal Penalty for a CD

If you are considering an early CD withdrawal due to higher current interest rates, you might think you can earn a better return on your investment (ROI) by moving the money to a high-yield savings account, money market account, or other investment. Calculating the cost of an early withdrawal can help you decide if it’s worth it.

First, understand your bank’s CD terms and how it handles early withdrawals. You’ll need to know:

• The penalty for your CD term
• How your interest compounds (daily or monthly)
• Whether the penalty is based on the entire balance or just 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, if you have $10,000 in a five-year CD with a 5% annual percentage yield (APY) and your bank charges a penalty of 150 days’ worth of interest for early withdrawal, 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 include:

No-Penalty CDs

No-penalty CDs may allow you to withdraw money without paying a penalty about a week after your initial deposit. The trade-off is a potentially lower interest rate, although this can vary. Unlike most savings accounts, your rate is fixed, and you may not need to maintain a minimum balance.

Brokered CDs

Brokered CDs are sold through a third party, usually a brokerage firm. They may offer longer terms and higher interest rates than bank-purchased CDs and 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 with varying terms. For example, instead of buying one CD worth $9,000, you buy three for $3,000 each—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 every six months without an early withdrawal penalty.

CD Barbell

With a CD barbell, you invest half your money in a short-term CD and half in a long-term CD. This strategy provides flexibility to access half of your investment at the end of the term without penalty while benefiting from higher interest in a longer-term account.

Are CD Early Withdrawal Penalties Tax-Deductible?

Generally, you will likely pay an early withdrawal penalty if you withdraw money from a standard CD before the maturity date. You can deduct the penalty amount, which may offset how much you pay in taxes on any interest earned, according to the IRS.

For example, if you earned $70 in interest but paid an early withdrawal penalty of $30, the full $30 can be deducted on your taxes. Early withdrawal penalties are included in Box 2 on the 1099-INT form from your bank or financial institution, labeled “early withdrawal penalty.”

It’s a Matter of Time

Most people invest in CDs intending 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 cover any financial setbacks.

Ensure 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.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We are here to assist you with the best mortgage solutions tailored to your needs.

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