Certificates of deposit are a safe way to invest your money while earning more with interest rates that are generally higher than your traditional savings account. CDs typically have a fixed-term length and fixed-term rate, with a minimum deposit required to open the account.

But there is a catch. When you open a CD, you agree to leave your money in the account untouched for a fixed withdrawal date also known as the maturity date. You won’t have regular access to your funds, but if you wait to cash out the CD when your term ends, you can withdraw the interest you earned along with your initial deposit.

What is a CD early withdrawal penalty?

However, suppose you decide to withdraw funds before the maturity date. In that case, you risk having an early withdrawal penalty, which can cost you some or even all your earned interest and could even dip into your principal. CD early withdrawal penalties vary from one financial institution to another. However, federal law requires that if a CD is to qualify as a time or savings account with a fixed term, financial institutions must charge an early withdrawal penalty if funds are withdrawn within the first six days after opening the account. The minimum penalty is seven days’ worth of interest. There is no maximum, so an early withdrawal beyond the first six days could cost you not only your interest but some of your principal too.

When you open a CD, you enter an agreement with a financial institution (FI). The FI agrees to pay you a higher interest rate for a specific term, and you agree to not withdraw your funds until the CD maturity date. FIs use your funds in loans or investments that yield higher rates while you’re waiting for your CD to mature. This is why you trade the ability to withdraw your money at any given time in exchange for higher interest rates. By breaking the agreement and withdrawing your CD funds early, you may cause the FI to exit their investment or loan early, which may incur financial penalties on the money they’ve invested or loaned out. Charging a CD early withdrawal penalty helps the financial institution to recover costs associated with their investments or loans.

CD early withdrawal penalties are typically waived due to death or legal incompetence of the account holder, and typically you can withdraw the interest that has been posted to the CD penalty-free.

Calculating Your Early Withdrawal Penalty

Depending on the FI and the CD, calculating your early withdrawal penalty depends on whether you’re charged on your total original deposit or the amount you’re withdrawing early. This amount will then determine your penalty – usually a set number of days of interest.

Calculating a penalty by the day is as follows:

Withdrawal or original deposit amount x (interest rate/365 days) x number of days’ interest = Penalty

For example:

$1,500 withdrawal x (5.5% current interest rate/365 days) x 90 days of interest = $20.34 penalty.

However, CD penalties can be based on whether interest is earned or not. This means if the penalty is 90 days of interest but is withdrawn before the CD is open for 90 days, part of the principal will be lost.

Avoiding CD Early Withdrawal Penalties

Ultimately, if you’re looking for liquid funds but still want to grab higher CD rates, there are ways you can avoid CD early withdrawal penalties, such as no-penalty CDs, CD ladders, CD bullets, and CD barbells.

Is it worth taking an early withdrawal penalty?

Sometimes withdrawing early may be worth the penalty to cover emergency expenses, make a downpayment on a home or car, or even reinvest the funds into a higher paying CD or other investment. The trade-off in penalty fees may be worth what you’d be saving in interest on credit cards or what you take out on a loan. Using a break-fee calculator can help determine if withdrawing your funds early from your current CD before maturity and using those funds to open a different CD can increase your net earnings.

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