CD withdrawals and renewals

Withdrawing money from a certificate of deposit before maturity usually attracts a penalty – for example, between 2 and 6 months’ interest.

Banks vary in their policy about early withdrawal.

Examples range from the Farm Bureau Bank FSB (Nevada) that reserves the right to retain up to 50% of all interest projected to be generated by the CD, to the Ally online bank that has a special No Penalty CD.

Withdrawal, even if it is partial, may also mean closure of the CD. Discouraging early withdrawal like this means that investors will typically only take their money out in an emergency or if they find a better investment opportunity elsewhere.

Is it ever worth withdrawing money from your CD early?

You can make a simple calculation to see how much better another investment opportunity has to be in order to justify paying a penalty for early withdrawal.  Suppose you have a CD with an initial deposit of $10,000, a five year maturity, an interest rate of 1% and a penalty of 6 months’ interest for early withdrawal. Your CD is therefore bringing you between $100 and $105 per year of interest (allowing for interest compounded monthly). A penalty of six months’ interest would therefore be around $52 – $53, depending on when withdrawal occurred.

You now find another five-year CD that pays 2%, which would mean interest payments of between $202 and $219 per year. The new CD pays between $102 and $119 per year more in interest than the old CD. In this case, unless you had less than a half year to run before maturing, its more profitable for you to accept the penalty for early withdrawal and immediately transfer your funds to the new CD at 2% (assuming you accept the time to maturity of the new CD and its terms and conditions).

A simple formula is:

$ Penalty For Early Withdrawal / $ Additional Annual Interest Needs To Greater Than The Amount of Time Left On the CD.

An answer of .5 in the above equation would mean that the existing CD would need to be more than 1/2 year from maturity to justify a switch.

What happens when your CD reaches maturity?

Shortly before your CD matures, you may receive notice mailed to you of this event with a request for your instructions. Whether or not this notice is sent to you is specified in the terms and conditions of the CD. In the notice, you are usually offered the choice between closing the CD and withdrawing your principal and interest, or using these funds to start a new CD (“rolling over” your CD). A certain “grace” period after maturity may be allowed for you to still cash in your CD without penalty.

The default choice, if you do not specify otherwise, is for the bank to roll your CD over. Banks may or may not specify in the notice mailed to you what the interest rate of the new CD will be. The new rate will not necessarily be the same as (as good as) the old one. As you will be penalized for withdrawing from the new CD you should make sure you read the terms and conditions of the CD carefully.