Long-Term CD Rates and Early Withdrawal Penalties - Updates and Concerns
I'm glad to see Pentagon Federal Credit Union (PenFed) kept its certificate rates the same for November. Its long-term CD rates are very competitive, and I was worried that PenFed might follow others and lower its rates. Here's a recap of PenFed's long-term CD rates:
- 3.49% APY 7-year CD
- 2.75% APY 5-year CD
- 2.50% APY 4-year CD
- 2.00% APY 3-year CD
Minimum deposit is $1,000. The rates are also available in an IRA. These yields are listed in PenFed's Money Market Certificates page as of 11/01/2010. Even though PenFed typically maintains CD rates through the month, they no longer guarantee it. For more details about PenFed CDs and membership, please refer to my PenFed CD review.
As a comparison to the top rates at internet banks, PenFed's 5-year CD rate isn't any better. You can also get a 2.75% APY 5-year CD at Sallie Mae Bank. However, for a 7-year CD, the best you can find at an internet bank is only 2.90% APY at USAA Bank (as of 11/1/2010) and that requires a $95K minimum deposit.
Early Withdrawal Yield Table
Below is an updated early withdrawal yield table that shows approximate average yields you would receive if you close these CDs early. It allows you to determine if it makes more sense to buy a long-term CD rather than a short-term CD. I also included Ally Bank's 5-year CD which has a 2.49% APY as of 11/01/2010 with only a 60-day early withdrawal penalty.
Approximate Yields After Early Withdrawal Penalties
|Year of Early Withdrawal||PenFed's 7-year 3.49% CD||PenFed's 5-year 2.75% CD||Ally's 5-year 2.49% CD|
|year 5||2.78%||2.75% (no penalty)||2.49% (no penalty)|
|year 7||3.49% (no penalty)||n/a||n/a|
As you can see from the above table, if you think you're going to leave the CD untouched for a little over 3 years, PenFed's 7-year CD is better than Ally's 5-year CD. For more details about Ally Bank's CDs and early withdrawal penalty, please refer to my Ally Bank CD review.
CD Early Withdrawal Concerns
Planning to utilize an early withdrawal on a long-term CD to get a better short-term CD has two potential gotchas: 1) the institution refuses to allow an early withdrawal and 2) the institution increases the early withdrawal penalty during the term of your CD.
Some institutions will include in their disclosures the right for them to refuse an early withdrawal request. That right does not appear to be in either PenFed's or Ally's disclosures.
The second issue is that the institution may decide to increase the penalty on existing CDs. I've received assurances from Ally Bank that they would not increase the penalty on existing CDs. Any changes would only affect future CDs (see post).
I do not have reason to believe that PenFed would change an early withdrawal penalty on existing CDs, but there may be some cause for concern. The reader me1004 posted in this forum thread the replies he received from Fort Knox FCU. Their compliance office appears to maintain that they have the right to increase an early withdrawal penalty on existing CDs. They claim that they only have to give members a 30 day notice before the change.
I'm continuing to look into this issue. Do other institutions have this same policy? And do their regulators have any stand on this issue? I think we all agree that the CD disclosure should be considered like a contract. If it states that the early withdrawal penalty is X, that should be in effect until the CD matures. If an institution can change an early withdrawal penalty on an existing CD, then what stops it from changing the maturity date or the interest rate?
I would NOT take the verbal word of any institutuion that they would not change such terms. That word will be worthless down the line if they actually do make such a change. While I don't like Fort Knox's policy, I find their honestly in raising the topic and divulging it up front commendable -- full disclosure.
I worry in particular now because this is a very good time for institutions to lure us in with assurances of a low early withdrawal penalty, and then when rates rise and we want to get out, they will suddenly significantly increase the penalty. They certainly are not going to want to think they have a lot of money longterm at these historically low rates only to sit on the side as it is all suddenly withdrawn by people seeking the higher rates. One of their defenses could be to significantly increase that penalty to stop the big outflow.
When it comes to modifying the penalty, usually the penalty is part of the CD which is a legal and binding contract. Unless the disclosure states they could change it in the future, they legally won't be able to. Of course, you would have to take one to court to enforce it.
I don't recommend people putting all of their funds into CDs with the hope of having their closure request honored, but I do feel for some CDs it is a risk worth taking. Most banks wouldn't want to deal with the bad PR that would come from not honoring closure requests.
I raised the issue in the Forums in conjunction with information from Fort Knox FCU. My last Forum posting is here:
In that posting, I provide the actual text of the communication I had with Fort Knox on this issue. I went up the ranks, and the following text of their final response comes from the Compliance Department, apparently the top authority on it at Fort Knox:
On 10/25/2010 08:18 AM, we wrote:
We can change the early penalty at any time. If you have a CD with us at the time of the change we have to give you a 30 day notice which would give you a chance to with drawn at the currect withdrawal penality.
On 10/22/2010 11:02 AM, you wrote:
Thank you for your response, especially adding in the second part. I must query, though. You say that AFTER I open a CD and establish that CONTRACT, you can change it at will to change the early withdrawal penalty?!
Please confirm. I guess I can't start asking for an entire legal basis for this, but I will say, as far as I know, once a contract is entered into, you can't change it (unless both parties agree, of course)! Are you REALLY saying that after I enter into a CD, you could change the amount of early withdrawal penalty that applies to it? Or, maybe you were saying that you could change it any time prior to me entering into it? Or??? I REALLY don't think you can do that legally once the contract is entered into.
So, you can see, I have already confronted them with the matter of a contract. They are not swayed, say they can change the early withdrawal penalty after the CD is opened anyway.
Since my last Form posting, I have tracked down their account agreement online. All it says about CD early withdrawal penalty is:
Early Withdrawal Penalties. You have agreed to leave the principal of this account on deposit for the full term stated in your account or renewal notice. If all or part of the principal is withdrawn before the maturity date, the Credit Union may charge you a penalty. Withdrawal of the principal amount of your Certificate may be made only with the consent of the Credit Union. Unless stated otherwise, the owner shall forfeit an amount equal to 90 days dividends whether earned or not. The penalty may be calculated at the rate paid on the deposit. The penalty will, if necessary, be taken from the principal amount of the deposit. The Credit 34
Union may grant a premature withdrawal request without penalty or with a reduced penalty in the event of the owner's death or legal incompetence; or if your account is an IRA account and the account is revoked within seven (7) days after IRA Disclosure Statement is received; or when the account is an IRA account and owner becomes age 70½ or disabled.
So, you can see, that says NOTHING about any possibility that the penalty can be changed after you open the CD. Nonetheless, they insist they can do so.
Elsewhere in that membership agreement it says CDs are subject to the terms of the "Schedule," as well as to "any account receipt or certificate." It also says something about changing the "Schedule," saying it can be changed at any time with proper notice -- but I note, it does not specifically say it can be changed after a contract for a CD is entered -- and I would think a contract would lock the terms.
Mind you, no where in the disclosure does it define what "Schedule" is or what it is talking about when it uses that term. It does have a glossary of terms, but "Schedule" is not in it! I have to guess that "Schedule" is the fee schedule, but that is just a wild guess. I note, there is no fee schedule on the Web site, and no "schedule" of any sort there, so I can't confirm that their fee schedule even includes the early withdrawal penalty. But maybe the early withdrawal penalty is in the Fee Schedule, and maybe they are saying the fee "schedule" can be changed at any time, although they don't specifically say it can be changed as applied to a CD after a CD contract is entered into, which I would think should lock it. Those parts of the membership account agreement follow:
Term Share Certificates. Any term share certificate, certificate or share certificate accounts offered by the Credit Union are subject to the terms of this Agreement, the Schedule, and any account receipt or certificate, which are incorporated herein by reference. IRA certificate accounts are also subject to the limitations imposed by federal law and regulations and to any limitations set forth in your Credit Union IRA Agreement, the terms of which are also incorporated herein by reference.
Account Rates and Fees. Our payment of dividends on your account(s) is subject to the account rates, fees, compounding and crediting policies and balance requirements set forth in this Agreement. We may transfer from any of your account(s) any charges or costs in connection with the operation and maintenance of account(s) as stated in this Agreement or the Schedule. You agree that we may change the Schedule at any time upon proper notice as required by law.
So, that's all I have. I'm not so sure that is any different than ANY other banking institution -- you have to follow all the entrails. I don't know any institution that doesn't reserve the right to change the fee schedule at any time. That is, despite some CSR at Ally or another institution saying they can't change the early withdrawal penalty once the CD is open, if this language from Fort Knox allows them to change the penalty in mid-CD term, then I'll bet they all have that possibility -- and might very well do so if circumstances develop appropriately. On the other hand, I'm not certain this language does allow them to change the early withdrawal penalty in mid-CD term. Fro one thing, you cannot then just close the CD without being penalized --and I think that might very well makes all the difference as for as the contract is concerned. That's why they can change it and apply it to a liquid account, but not to a CD -- unless they were to allow you to close the CD without penalty if you don't want to accept the new penalty arrangement. But Fort Knox say while you could close it before the ned of the 30 day notice to avoid the higher penalty, they say you would still be subject to the old penalty if you do so.
But I note, I challenged three times, went up the ladder and they are holding to their point of view. They might very well know thee law better than I do. And so ALL institutions might very well be able to do this -- and so just might do this. Under the current unusual and unique economic situation, I would not predict on the basis of past behavior what they might do maybe two years from now.
Or, if Fort Knox is wrong, perhaps someone -- meaning some lawyer -- might want to set them straight with some official advice.
Withdrawal of the principal amount of your Certificate may be made only with the consent of the Credit Union
They don't have to let you withdraw early at any penalty.
If all or part of the principal is withdrawn before the maturity date, the Credit Union may charge you a penalty.
Note the penalty is not specific in this sentence, it just gives them blanket right to charge a penalty.
Unless stated otherwise, the owner shall forfeit an amount equal to 90 days dividends whether earned or not.
This seems to give them the right to state otherwise, or change the withdrawal penalty. Taking all this I think they could exercise their right to not consent to the withdrawal with the penalty in the original agreement but state otherwise that they would consent to withdrawal at a higher penalty.
Note: I only opened the CD there in the first place, because they gave me a higher rate for being a long term customer, but this 'changing the rules in the middle of the game" thing lost them any future business of mine.
Ally seems to have very, very similar language in their disclosures, meaning they, too, might very well be able to change the early withdrwawal penalty in mid-CD! The CSRs' comments seem to be very wrong and midleading.
As with Fort Knox, Ally does not say that in the section where they tell of the early withdrawal penalty:
• Early Withdrawals — You may not make a partial withdrawal of funds you deposit in a CD prior
to the maturity date. If you withdraw all of the funds you have deposited in a CD prior to the
maturity date, we will close your CD, add the accrued interest to date to the balance and impose
a penalty on your early withdrawal. The penalty imposed will equal sixty (60) days of interest.
This penalty does not apply in the case of death or legal incapacity of any owner or in the case
of the Ally No Penalty CD, which does not allow withdrawals on the date you fund your account
or during the first six (6) days following the date you fund your account (except for the death or
legal incapacity of any owner). If you have a Raise Your Rate CD, the 60-day interest penalty will
be calculated using the interest rate that applies to your Raise Your Rate CD at the time of your
Also as with Fort Knox, Ally elsewhere says its service fees may change at any time:
18. Service Fees
While there are no monthly service fees, there may be service fees that apply to certain requests
or actions. Please see our Fee Chart, Appendix A. These fees may change from time to time and
in accordance with applicable law. We will provide you notice to the extent required by law.
Again, I note, with Fort Knox, I could not find the Fee Schedule online, so cannot even see if the early withdrawal penalty is listed there. I did find the Ally fee schedule, and I see nothing of the early withdrawal penalty in Ally's fee schedule. So, the fact that Ally reserves the right to change its fee schedule should not affect any early withdrawal penalty; but that question remains open for Fort Knox.
But the key to the question comes in another section of the disclosure, where it says pretty much exactly what Fort Knox has said, that they can change your account or anything in the disclosure (which would include the early withdrawal penalty) at any time -- and your option if you don't like it is to close your account. They say nothing about NOT applying the existing early withdrawal penalty if you do close following notice of a change to the penalty, so it would seem the penalty would be applied; Fort Knox explicitly says the penalty will be applied:
34. Changes in Terms
Please be aware that accounts or services can change over time. We reserve the right to delay,
discontinue or make changes to accounts or services, and to convert your existing accounts and
services into new accounts and services. You may not get advance notice of this. We may change
this Agreement, and we may add to or delete from this Agreement, and the updated agreement will
supersede all prior versions. We will provide notice of changes, additions, and deletions as required
by law. If you do not agree with a change, you may close your account(s) before the effective date
of the change, addition or deletion.
So, it seems this question of changing the early withdrawal penalty in mid-CD quite possibly is something ALL financial institutions reserve the option to do. This is a serious risk that can undermine any plan to get a higher return by taking a longterm CD with a small early withdrawal penalty with the idea you will close it early and still end up with more than you would have in a shorter term CD despite the penalty. The penalty might very will change to being high during mid-CD, and all your arithmetic might go down the drain.
Daddy Warbucks searches for the best "hot money" deals here on Ken's site. Daddy finds a three-year CD at 3% at Bank of Little Morals and buys a $200,000 CD. Daddy has no other relationship with Bank nor any leverage over its other customers or regulators. The stated penalty for early-withdrawal is two months interest. Two years into the CD, interest rates spike to 6%. Daddy does the math and figures he'd rather make $12,000 interest in year three than $6000, and he'll gladly forfeit $1000 interest to do so. Bank tells him the penalty for early-withdrawal is "now" 12 months interest. Daddy advises Bank that a material inducement to his purchase of the CD was the two-month penalty, and that Bank is thereby estopped to change the penalty. He's right, of course. Bank's lawyer tells Daddy to go pound salt. Daddy's "damages" are $5000. Even assuming Daddy can get jurisdiction over Bank in Daddy's local small claims court (it's complicated, but it turns on what a court deems the "last act" to be, which is generally funding), and Daddy wins, all Daddy has is a judgment. To get his $5000, Daddy has to find and attach Bank's assets, which are no doubt way, far, away. Ever try to collect a sister-state judgment for $5000?
Now, lop off a zero (a $20,000 CD) and do the math.
I guarantee you, if banks are good at anything, it's math.
And those banks are doing it in TODAY'S climate. In two years when interest rates are rising, and potentially even skyrocketing (I can hope, can't I?!), banks will have serious incentive to try to stop an outflow of longterm CDs being broken, meaning an incentive to notably increase the early withdrawal penalty. The biggest incentive would be for those with the biggest outflow, which is going to be the ones with the lowest early withdrawal penalty today as they are where the big numbers of people doing the math today are going to take this approach.
I further agree with Lou that if we persist in challenging these institutions to the nth degree we are only hastening more restrictive language, smaller service areas (in-state only), etc. I think you have their answer and should drop it at this point. We already know the power of 1000's of rate chasers ... look at Reliabank dropping their rate the same afternoon that Ken posted their 3.05% 55 month CD. Not likely that was a conincidence.
There's not much I can contribute. I concur on the extreme importance of this issue but my concurrence is not worth much.
In my own experience I have not had to deal with this precise matter prior. Closest I came was roughly seven or eight years (not sure) ago. Was wanting to open a CD down in TX at high rate of interest. After reading all the disclosures I decided the right (only) of early withdrawal was not sufficiently assured. I wanted the account so I contacted an officer of the bank and explained my concern. He quickly re-assured me there was no problem. I then requested a private letter from him, backing up his spoken assurances. I received the letter and opened the account. Some years later, with interest rates up, I did close the account early and there was no trouble.
For all of you who are whining about whether Ally can refuse a CD early withdrawal or change the EWP on an existing CD, just ask her and tell her to post her answer here.
This is getting stupid.
The EWP is awfully steep UNLESS you are interested in an IRA CD and you are in your late 50's or more. Partial w/drawals from IRA CD's are allowed w/o penalty once you are 59.5 years old; you must maintain a $1,000 balance in the IRA CD. So, if the rumored 10 yr. CD @ 5% or thereabouts materializes in a few months, you can take out all but $1,000 with no penalty and invest it in the longer term, higher rate IRA CD
The customer service people there have been great.