Ally Bank's 5-Year CD as an Alternative to Reward Checking?

Reward checking is one way savers can still get a decent interest rate for their savings. Many reward checking accounts continue to pay between 3% and 5% APY. This is higher than most long-term CD rates these days. However, there are several downsides with reward checking such as balance caps and debit card usage requirements. Is there an easier way to get similar returns with less work?

One strategy is to use a combination of Ally Bank's 5-year CD and its money market account. The 5-year CD provides a rate that's close to reward checking rates. The money market account gives you checking-like liquidity. If you need to make more than 6 withdrawals per month, you can open Ally's Interest Checking Account. In this strategy, you would keep most of your savings in multiple 5-year CDs. The money market account would be used for money you need for monthly expenses.

Unfortunately, Ally Bank's 5-year CD rates have been falling in the last couple of months. Earlier this year the yield was over 3.00%. It's now 2.69% APY as of 9/20/2010. However, once you open the CD, you don't have to worry about rate cuts for 5 years. It's easy to beat this rate with reward checking. However, there's no guarantee reward checking rates will last. As we've seen in the last year, rates have been falling, and this may continue as new regulations take effect.

You do lose a little liquidity with Ally's 5-year CD. However, it's not that much thanks to Ally's very mild early withdrawal penalty of 60 days of interest. If you need the money before 5 years, you can close the CD with the penalty. The annual return net of the penalty is better than any short-term CD rates. The following shows these estimated annual returns if the 5-year CD is closed at year 1, 2, 3 and 4:

• 2.24% if closed after 1 year
• 2.46% if closed after 2 years
• 2.54% if closed after 3 years
• 2.58% if closed after 4 years
• 2.69% if kept to the full 5-year maturity

One important thing to note regarding the Ally Bank CDs is that Ally does not allow a partial withdrawal of principal. The whole CD must be closed. So it make sense to open multiple small CDs rather than one large CD. If you need some of the money, you can just close one of the small CDs. Please refer to my Ally Bank CD review for more details. Some have been worried about the chance that Ally could increase the early withdrawal penalty. There should be no risk of this for existing CDs (see post).

The main downside with the Ally Bank strategy is that the rate is now far below 3.00%. Some credit unions still offer 5-year CD rates of 3% APY, and if you go to a 7-year CD, you can get yields up to 3.49% APY. However, these CDs have early withdrawal penalties much higher than 60 days of interest. A penalty of 1-year of interest is more common for 7-year CDs. So these long-term CDs can provide you with a little higher returns than Ally, but you'll have less liquidity. Please refer to this post to see how Ally's 5-year CD compares to PenFed's 7-year and 5-year CDs.