Certificates of deposit (CDs) are a popular savings product for retirement planning due to their stability and guaranteed interest rates. However, if you prefer the flexibility of accessing your deposit anytime, you may encounter a CD early withdrawal penalty. 

Understanding how CD withdrawal penalties work and how they can affect your financial strategy is fundamental before contributing your money. Let’s explore why financial institutions impose penalties, strategies to avoid penalties, and alternatives to CDs, like annuities. 

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What’s a CD, and why is there an early withdrawal penalty?

A CD is a contract between you and a financial institution. Banks and credit unions can often pay higher interest rates on CDs than savings accounts because you generally give up access to your deposit until your contract’s maturity date.

To deter you from breaking your contract and withdrawing all or part of your money early, your CD issuer can imposes a penalty. The CD early withdrawal penalty is usually a portion of the interest you would earn if you left your money in the CD until maturity. 

CD early withdrawal penalty example

If you contribute $5,000 to a 12-month CD that pays a 5% interest rate, your penalty might be three months of interest for early withdrawal. In this example, that would be ¼ of the $250 you anticipated making, or $62.50. If you contribute to a longer-term five-year CD, your penalty might be one year’s interest. It is important to read the terms of the CD to determine the penalties for early withdrawal.

Why the CD early withdrawal penalty is necessary

Say you contribute $10,000 to a five-year CD with a 4% interest rate. After a year, CD rates for similar accounts are yielding 5.5%. If the penalty didn’t exist, you might close your CD and open a new one at a higher rate. If the interest rates move high enough, you may still choose to do this. But the bank can reclaim some of their costs with the penalty.

What usually happens if you withdraw from a CD early?

You can withdraw money from a CD, but the CD issuer typically applies the penalty automatically. These are the consequences of early withdrawal:

• You lose interest: Not only does the issuer deduct a portion of your interest, but you also lose the opportunity to earn future interest. Even if you haven’t earned any interest on your CD, you’re still responsible for the penalty, which the issuing institution will deduct from your principal.

• The penalty is automatic: The penalty is a contractual obligation, and the CD issuer will take it before remitting your deposit to you. 
• There’s typically a greater impact for long-term CDs: The longer the term of your CD, the steeper the penalty may be. A one-year CD may have a much lower penalty than a five-year CD, with all other factors equal. 

Strategies to avoid CD early withdrawal penalties

No one generally wants to pay penalties on their CDs, but early withdrawal is sometimes the best course of action. Here are some strategies to avoid jeopardizing your interest.

Opt for no-penalty CDs

With no-penalty CDs, you can withdraw money without incurring a penalty — similar to high-yield savings accounts. However, banks, credit unions, and brokerages may offer lower interest rates for no-penalty CDs in exchange for this flexibility.

Opt for annuities 

Some fixed annuities work similarly to CDs but have several advantages. For example, some annuity products allow you to withdraw up to 10% of your contract value every year without paying a surrender charge to the insurers. This may be an option for folks wanting to access part of their deposit early for an unexpected expense like a down payment on a car or house. You may withdraw more than 10%, but surrender charges usually apply, which can be substantial and can reduce your principal. Keep in mind that annuities are long-term financial products generally meant for retirement so any withdrawal you make before age 59 ½ may also be subject to a 10% IRS tax penalty.

Annuities typically offer higher interest rates than CD products with a comparable maturity date. For example, a 10-year fixed annuity may provide a better interest rate than a 10-year CD. 

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Use a CD ladder strategy

A CD ladder spreads your contribution across multiple CDs with staggered maturity dates. You can create a CD ladder or tell your financial advisor that you’re interested in this strategy. 

Let’s say you want to create a CD ladder with $25,000. The example below explains how this may work.

1. Divide your contribution into equal parts: First, you would select five different CDs, and contribute $4,000 to each 
2. Select your maturity dates: Then you determine how far out you want to stagger your CD maturities. Let’s say you decide to space your CD maturity dates one year apart. You’re contributing to five CDs, so your maturity dates would be one, two, three, four, and five years. 
3. Withdraw or reallocate: At the end of the first year, the one-year CD reaches maturity. If you need access to the funds, you can collect them without penalty. If you don’t, you can reinvest in a five-year CD to maintain your five-year horizon. 

This is just one example of a CD ladder. You can also build a mini CD ladder with shorter maturity dates or create a long-term ladder with a greater number of periods. 

Qualify for a penalty waiver

Under certain circumstances, you may qualify for a penalty waiver from the financial institution issuing the CD. Valid reasons for a penalty waiver may include the death of the CD account holder, a medical crisis, or a catastrophic accident. To find out whether you qualify for a penalty waiver, check the terms and conditions of your CD. 

FAQ

Can you withdraw interest from a CD without penalty?

It depends on the CD issuer and the terms of your CD. However, withdrawing the principal usually triggers a penalty. 

Can you take money out of a CD early?

Yes, you can always withdraw money from your CD — even before the maturity date — but you may incur penalties. You may lose a portion of your principal if you withdraw funds before your CD has accrued enough interest. 

What’s the financial impact of early withdrawal penalties?

The answer to this question depends on the interest rate and maturity date of your CD, as well as the individual terms of your contract. If you withdraw money from a short-term CD account, you may only lose a few months' interest. If you have a long-term CD and deduct funds early, the financial institution may deduct a year’s interest or more. 

So, what’s the penalty for early withdrawal of a CD? This example shows how much the maturity date can affect your CD early withdrawal penalty. The penalties are for illustrative purposes only and a CD may have lower or higher early withdrawal penalties. You should read the CD terms carefully.

• $125: The penalty for early withdrawal of a $10,000 contribution in a 5% one-year CD with a three-month interest penalty.
• $500: The penalty for early withdrawal of a $10,000 contribution in a 5% five-year CD with a one-year interest penalty.

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This communication / article is for informational / educational purposes only.

It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice.

The Gainbridge^® digital platform provides informational and educational resources intended only for self-directed purposes.

Individual licensed agents associated with Gainbridge^® are available to provide customer assistance related to the application process and provide factual information on the annuity contracts, but in keeping with the self-directed nature of the Gainbridge^® Digital Platform, the Gainbridge^® agents will not provide insurance or investment advice.

^{Annuities are issued by Gainbridge Life Insurance Company, a Delaware-domiciled insurance company with its principal office in Zionsville, Indiana. All guarantees are based on the financial strength and claims paying ability of the issuing insurance company. Withdrawals above 10% free withdrawal amount are subject to a withdrawal charge and market value adjustment. Withdrawals of taxable amounts are subject to ordinary income tax and if made before age 59½, may be subject to a 10% federal income tax penalty. Distributions of taxable amounts from a nonqualified annuity may also be subject to an additional 3.8% federal tax on net investment income.}