The Best CD Rates and the Smallest Early Withdrawal Penalties

In this post I review four institutions with top long-term CD rates with relatively mild early withdrawal penalties. Many people assume we will see very high inflation and eventually very high interest rates that result from that inflation. That is a risk, but we shouldn't forget the Japan scenario in which interest rates stay low for many years. That is also a risk. A long-term CD with a mild early withdrawal penalty can be helpful to protect against both risks.

In February we had started to see some higher long-term CD rates. Unfortunately, that didn't last. The banks that were offering special 5-year CDs with a 3.00% APY have cut their rates. Long-term CD rates at credit unions have also been falling. Pentagon Federal Credit Union cut their CD rates in March and are no longer rate leaders. Fort Knox FCU just recently cut their long-term CD rates.

So if you're looking for the best CD rates, you will likely be disappointed. If you want a yield of at least 3.00%, it's not easy to find. For nationally available CDs, Connexus Credit Union is offering 3.00% APY on a 5-year CD, but this requires an active checking account. There are more 3.00% CDs for terms over 5 years. Navy Federal Credit Union is offering 3.05% APY on a 7-year CD with a $20K minimum deposit, but you must have a military connection to be eligible to join.

Some of the banks that have the highest CD rates may not be the best deals due to their harsh early withdrawal penalties. Some examples of these banks and credit unions include Melrose Credit Union, Sovereign Bank, Capital One and Apple Federal Credit Union.

So here's a list of four institutions with top long-term CD rates and relatively mild early withdrawal penalties. Below this list, I've included a table which shows the effective yields from these CDs if you make early withdrawals.

The first institution is a bank that I've mentioned many times before. It's Ally Bank, and its CDs only have a 60-day early withdrawal penalty. Its 5-year CD rate isn't the best (2.40% APY as of 3/21/2011), but with only a 60-day early withdrawal penalty, this becomes a good deal especially if you need to close the CD before the first 3 years. One thing to note with Ally CDs is that you can't do partial withdrawals. So it makes sense to open multiple small CDs rather than one large CD. Refer to Ally Bank's account disclosure for the full details.

The second one is Discover Bank which is offering a 3.00% APY 10-year CD. Ten years is definitely a very long term, but Discover Bank's early withdrawal penalty for terms over 5 years is 9 months of simple interest on the amount withdrawn (see Discover Bank's FAQs). This is smaller than the penalty for 7-year CDs at both PenFed and Navy Fed (both have a 12-month penalty).

The third and fourth ones are tied. Digital Credit Union and Kaiser Federal Bank are offering a 5-year CD with a yield close to 2.75% APY. DCU's 5-year CD yield is actually 2.76% APY for a $25K minimum deposit. Members can get 3.01% APY if they have a Loyalty Checking Plus relationship. The Kaiser Federal Bank's 5-year CD is a special with a $10K minimum deposit requirement. Both of these CDs have an early withdrawal penalty of 180 days of interest. I have more details in my DCU CD review and my Kaiser Federal CD review.

Below is an 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.

The early withdrawal yields listed below are based on the spreadsheet developed by Bogleheads forum members. It's available from the Bogleheads Wiki: Comparing CDs. It should be noted that the following simple formula comes very close to this spreadsheet:

Post Penalty APY = (Full APY) x (D - P) / D

D = days into term when the CD was closed.
P = days of the early withdrawal penalty

These CD rates are based on the rates listed at the institutions' websites as of 3/21/2011.

Approximate Yields After Early Withdrawal Penalties

I don't have any updates to the potential risks of long-term CDs that I discussed in this November 2010 post. This includes the risk that the bank could increase the early withdrawal penalty on existing CDs. I've received an assurance from Ally's public relations director that the penalty would not be increased on existing CDs.