Certificates of Deposit (CDs) are considered among the safest investments because the principal is insured by the Federal Deposit Insurance Corporation. You don't risk losing money as in most investments, and you're guaranteed a particular rate of interest for the life of the CD. But, if you cash the CD in early, penalties might eat into your original investment. Just how much depends on the term of the CD.
The Federal Reserve loosely regulates how much banks can charge you in penalties of you break the terms of your CD. All they stipulate is the bank must charge at least seven days of lost interest if you cash in during the first week. You'll be lucky to find a bank that doesn't take advantage of that open-ended rule and charge more.
Under 12 Months
Typically, shorter-term CDs have smaller penalties than longer term CDs. Cash your 12-month or shorter CD and you'll forfeit at least three months of simple interest, but check your own bank's current policies for the specifics. In 2011, some of the larger banks, including Bank of America and Wells Fargo, went for a flat rate of $25 plus 1 percent of the principal. If the rate on your CD is under 1 percent, you're actually losing money on this transaction.
12 Months or More
Penalties for CDs of one to five years typically run about six months of interest, and CDs with terms over five years will cost you nine months of interest, on average. Bank at one of the larger institutions with the percentage policy and breaking one of these will cost a whopping 3 percent, on top of the $25 flat charge. Again, call your bank for their current fees, but be prepared for a shock.
The Fine Print
If you're thinking your bank can't change policies mid-stream, check the contract you signed when you opened the CD. Most actually say the bank reserves the right to change fees or penalties. If your contract doesn't leave that door open, then escalate the issue if you find the bank is trying to charge you more than your contract specifies for early withdrawal.
The silver lining in this very gloomy penalty cloud is the Internal Revenue Service allows you to take a tax deduction on the early penalty amount. It's a reduction in taxable income, so it's not a dollar-for-dollar return on your loss. Your bank will send you a form 1099-INT with the penalty amount in Box 2. Report the penalty on line 30 of Form 1040.
- Federal Reserve Board: Regulation D and Reserve Requirements
- Los Angeles Times: Early Withdrawals From CDs Get More Expensive At Bank of America
- Banking My Way: Avoiding Early CD Withdrawal Penalties
- Bankrate.com: CD Investors: Beware the Fine Print
- Internal Revenue Service Publication 550 (Investment Income and Expenses)
- Federal Deposit Insurance Corporation: Certificates of Deposit: Tips for Savers