When you see the newest must-have gadget, your mind probably starts racing with thoughts about how you're going to pay for it. If you're thinking about the money you've been saving in CDs, unless they're about to mature, you should probably look elsewhere. Liquidating a certificate of deposit before maturity can have significant financial consequences.
CDs are deposit accounts offered by banks that require you to keep the money in the CD for a specified period, or term, until the CD matures. This allows the bank to make more loans because it assumes it will have the money for the specified period. To entice customers to commit their money for the period, banks typically offer higher interest rates on CDs compared to savings accounts to make up for the fact that you're not able to withdraw from the account without penalty whenever you want.
If your CD hasn't matured yet, you're going to have to pay a penalty to get your money out of the account. Since the bank was expecting to have your money in its account until the CD matures, if you take it out early, you're going to have to pay a penalty. Generally, the only way to avoid these penalties is to wait until the CD matures.
According to a survey by Bankrate.com published in 2010, the average early withdrawal penalty depends on the CD's term. Banks charge, on average, three months of interest for CDs with maturities of less than one year and six months of interest for CDs with longer maturities. Some CDs permit the penalties to come out of your principal if you haven't accrued enough interest yet. For example, if you have a CD that charges a penalty equal to six months of interest but you've only had the CD open for four months, the bank will take the equivalent of two months of interest out of the amount that you put into the account to satisfy the penalty.
When you liquidate your CD, you have to report on your tax return any interest accrued on the CD during the year. For example, if you liquidate it at the end of March, you have to include the three months of interest as taxable interest income. Any interest from previous years should have been reported in those years. If you pay an early withdrawal penalty, you can claim that amount as a separate deduction. Your bank reports any interest and penalties on a Form 1099-INT that you receive after the end of the year.