Are Early Withdrawal Penalties from CDs Ever Worth It?

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Point of Interest

CD early withdrawal penalties can be deceivingly complex, so be sure you understand how these penalties can affect you before closing your account early.

For investors looking to earn some interest on liquid cash, a certificate of deposit (CD) can be an easy way to earn more money than a traditional savings account without tying up your funds until retirement or risking them in a volatile stock market.

Like many other financial accounts, CDs at different banks can have different rates and, more importantly, penalties. When investing in a CD, remember that you are committing to keep your money invested for a specified time period, so pulling funds out early can subject you to early withdrawal penalties.

However, even with the penalties, cashing out a CD could make financial sense in some situations. It depends on how large the penalty would be, versus the size of the need or opportunity you’re otherwise missing out on. To determine whether early withdrawal penalties make good financial sense for you, consider the penalty structure and your reasons for taking your money out.

How much are early withdrawal penalties for CDs?

Unlike many other account penalties, early withdrawal penalties on CDs are generally listed as an amount of interest over a specific time. But the amount of interest and the range of time varies from lender to lender. Here are a few examples of penalty rates on a one-year CD with national lenders:

  • Marcus/Goldman Sachs: 270 days simple interest on the principal at the rate in effect for the CD
  • Capital One: 3 months interest on the principal
  • Bank of America: 180 days interest on the amount withdrawn

This complex penalty system can make it difficult to compare rates across different providers, so it’s best to calculate the penalty in dollars for  a more consistent comparison. To calculate the penalty for early withdrawal of CD, follow these steps:

  1. Determine whether your bank assesses penalties on the entire principal or only the portion withdrawn.
  2. Take the amount from step one and multiply it by the interest rate on the account divided by 365 if interest is calculated daily, or the interest rate on the account divided by 12 if interest is calculated monthly.
  3. Take the calculation from step two and multiply it by the number of days or months specified in your bank’s penalty calculation.

As an example, investing $10,000 in a one-year CD with Capital One will currently pay interest of 0.50% APY*. Capital One does not allow for partial early withdrawals, and the specified penalty is 3 months of interest on the principal. The penalty would be calculated as $10,000 * 0.005/12 * 3 = $12.50.

Similarly, investing $10,000 in a 12-month CD with Bank of America will currently pay interest of 0.03% APY*. Bank of America’s early withdrawal penalty is 180 days interest on the amount withdrawn. An early withdrawal of $5,000 on this account would incur a penalty of $5,000 * 0.001/365 * 180 = $2.47. While these penalties may not seem expensive, they can accrue quickly on larger principal amounts. 

Additionally, some banks have minimum withdrawal penalties. For example, even if the calculated penalty based on the principal balance, interest rate and CD term is $12.50, the bank may specify that any early withdrawals incur a penalty no less than $25.  

* Rates current as of September 2020.

When it’s worth it to take the withdrawal penalty

Since financial situations and interest rates are constantly changing, there may be times when an early withdrawal is warranted, or even necessary. It may be worth taking the withdrawal penalty on your CD when:

  • Interest rates are rising and you can make money in other investments – If your cash is locked up for the next 28 months and you have an excellent opportunity to invest at a significantly higher interest rate, it may be worth taking the penalty. Even if your penalty amounts to several hundred dollars, it could make sound financial sense. Calculate the amount of interest you expect to earn in the new investment and subtract the CD early withdrawal penalty. If the remaining amount is still more than you’d earn by staying in the CD, it’s generally a good idea to take the penalty.
  • Leaving funds in the CD will cause excessive penalties elsewhere – Patience in saving is important, and you don’t want to withdraw funds every time you feel a pinch in your finances. However, major financial emergencies can be a good reason to close out a CD early. If you are facing foreclosure, repossession or thousands of dollars in penalties for other debts, taking a small penalty on your CD is worth it when it can give you access to the liquid cash needed to resolve your other financial obligations and avoid significantly more in fees.

When it’s not worth it to take the withdrawal penalty

Although some penalty dollar amounts may seem small, it could still end up being a bad money move in the long run. It’s generally not worth taking the withdrawal penalty on your CD when:

  • The penalty is more than the accrued interest on the account – Although the penalty for CDs is based off the accrued interest, banks won’t hesitate to take cash from your principal if the earned interest on your account doesn’t cover the penalty. When your penalty amounts to more than you’ve earned, your CD investment ends up costing you money instead of helping you earn it.
  • You need quick cash to make a purchase – Avoid the temptation to cash out your CD whenever you want to make a larger purchase. Early withdrawal penalties aren’t worth it for large purchases like a new car or family vacation. Instead, plan for these purchases by saving additional funds so you can keep your CD intact and earning you money.
  • Interest rates are dropping – When the economy starts trending down and interest rates are dropping, it can often cause panic selling of stocks or panic withdrawals of CDs and other investment accounts. In these situations, holding your money in place is the best strategy – CDs aren’t tied to the stock market, so you won’t lose your principal.

The final word

When investing in a CD, it’s important to understand the nuances of your account, including how early withdrawal penalties are calculated and applied. CD accounts are intended to be a commitment for a specified time period, and early withdrawals shouldn’t be taken lightly. In certain financial situations, however, it could make sense to absorb the penalties in favor of cost savings or better-earning opportunities elsewhere. Put in your due diligence and evaluate your situation to choose the best money moves for you.