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Checking and Savings Account Complaints Increased by 31.9% in 2023Deposit Account Strategies for 2017
As of today, 88% of the readers who took my Fed Rate Hike Poll anticipate three or fewer Fed rate hikes in 2017. This prediction is inline with what the Fed suggested last month with its dot plot and inline with the current Fed fund futures, which indicate only a 14% chance of more than three rate hikes in 2017 (Please take the poll if you haven’t already).
This is a good reminder that rate hikes this year (and in the next couple of years) will likely to be gradual. That’s important to remember when you’re deciding how much of your “safe” money should go into long-term CDs and how much should go into short-term CDs and liquid accounts (i.e. savings, money market and checking accounts). If you put too much in savings accounts, you may lose out while you wait for higher rates. However, rates could rise faster than expected, even though this seems unlikely. In this case, you may be stuck in a low-rate CD that’s earning less than top savings accounts.
So what’s the best deposit account strategy in 2017? I think long-term CDs still make sense, but there are some techniques to use that can minimize the risk of having too much money stuck in a low-rate CD. You may want to depend more on internet savings accounts. If you do, there are some issues to consider. You may also want to consider special CDs like step-up CDs and penalty-free CDs. However, they may not have as much value as they seem. In the following discussion, I’ll review these techniques and issues that should help you form your deposit account strategy for 2017.
CD Ladders and CD Ladder Variations
If you want to keep things simple, establish a standard CD ladder. In a standard CD ladder, you’ll have multiple CDs with CDs maturing at regular intervals. In a rising interest rate environment, CD ladders provide more opportunities to roll over maturing CDs into new higher-rate CDs.
CD ladders are often started with short-term CDs in addition to long-term CDs. When the short-term CDs mature, they are rolled into long-term CDs. Eventually, all of the CDs in the ladder are long-term CDs. Since many short-term CDs have low rates, it can make sense to use an internet savings account rather than a short-term CD. This is especially the case for CDs with terms under one year.
One variation of a standard CD ladder is a barbell CD ladder in which half of the deposit accounts are in long-term CDs and the other half are in short-term CDs. If rates rise faster than expected, you’ll see the benefits quicker with the short-term CDs. As mentioned above, short-term CDs often have lower rates than internet savings accounts. So instead of maintaining half of the money in short-term CDs, it can make more sense to use internet savings accounts or high-yield reward checking accounts (Depending on how much money you have and how much work you want to do.
CDs with Mild Early Withdrawal Penalties
Whether you decide to have one CD or multiple CDs in a CD ladder, it makes sense to choose CDs with mild early withdrawal penalties (EWPs). I consider a mild EWP to be no more than six months of interest for a 5-year CD. In a DA study, we’ve shown that you often don’t sacrifice interest rates when you chose a CD with a mild EWP. You can compare the effective yields of CDs after the early withdrawal penalties by using our CD early withdrawal penalty calculator. Be aware that there are risks on depending on an early closure of a CD ( see article).
Issues to Consider for Your Internet Savings Accounts
If you do plan to keep more in internet savings accounts while you wait for rising rates, keep in mind that many internet banks often don’t remain rate leaders. This is especially true for those that offer introductory rates. After the promotional rates are over or when the internet bank falls behind on its rates, you may want to move that money to the next savings account deal or to a hot CD deal. It’s important that the internet bank makes it easy for you to quickly move that money. The internet bank’s bank-to-bank ACH transfer service should be fast (taking no more than one or two business days). Also, its transfer service shouldn’t have small limits on the amount that can be transferred. I’ve seen internet banks that have limits under $5k which can make the transfer system of little use for those with $100k or more in deposits.
After you have moved your money, be careful about fees. If the savings account has a minimum balance to avoid a monthly fee, that could prevent you from moving some of your money into the better deal. You could close the account, but you have to make sure you had it opened long enough to avoid an early closure fee.
Also, be careful about inactivity fees. If you keep a savings account or reward checking account opened after you have moved most of the money into a better deal, that account may not have any more activity. Some banks start charging a monthly inactivity fee in as little as three months. An easy want to ensure you have an activity is by setting up small transfers that automatically take place on a monthly basis. Just be sure that ACH deposits or withdrawals will be counted by the bank as an activity.
Beware of Special CDs
Step-up CDs (also called bump-up, raise-your-rate CDs or ramp-up CDs) may seem like a good deal in a rising interest rate environment, but they probably won’t be as useful as you think. These are CDs that give you one or more options during the term of the CD to increase your rate to the current rate of that same step-up CD product. DA contributor, Charles Rechlin, wrote about these in this article and explains why these CDs are dubious in value. As he described in the article, he’ll “pass on step-up CDs unless the initial rate offered is at, above or at least reasonably competitive with the best rate available nationally for a CD of the same maturity with no step-up right.” I will also add that it can be difficult to determine when to exercise the option to bump-up the CD rate. If there’s only one option to step-up the rate, there will always be the worry that you’re bumping up too soon. If you wait too long, the benefit of the higher rate will be small.
Another useful special CD in rising rate environments is the penalty-free CD. This type of CD may provide a totally free early withdrawal of the entire balance (Ally Bank’s No Penalty CD is one example), or it may provide a free withdrawal for only a portion of the balance. There are also types that only allow penalty-free withdrawals during specific periods of the term (such as within a year of maturity). First, this type of CD should have a rate that’s higher than the best internet savings account rate. The savings account rate may not be guaranteed to last like the CD, but in a rising rate environment, this guarantee is less important. If you can find a penalty-free CD with a competitive rate, make sure you are aware of the withdrawal requirements and limitations. For example, Ally Bank does not allow partial withdrawals. If you do an early closure of its No Penalty CD, you have to close the CD and withdraw the entire balance. For a case like this, it makes sense to open multiple CDs rather than just one in case you need that money in the future. Be careful if there are too many rules to a penalty-free CD. If the penalty-free feature allows only a partial withdrawal or allows withdrawals only during specific periods within the CD term, it may not be worthwhile, especially if the rate isn’t competitive to standard CDs with similar terms.
Hot Long-Term CD Deals
What if a bank or credit union comes out with a very competitive rate on a long-term CD that does not have a mild early withdrawal penalty? We may see more of these since banks and credit unions have been raising their early withdrawal penalties in recent years. PenFed Credit Union is one of these. This can be a difficult decision since no one can be sure about future interest rates. If interest rates rise only gradually, putting at least some of your money into these types of CDs will be good deals. I’m sure many of you are glad you opened those PenFed 3% CDs in 2013 and those PenFed 5% CDs in 2011. At those times, many people thought rates would be higher now than they are. Interest rates may surprise us on the upside, but based on history, interest rates are more likely to disappoint us.
Example: Joe is "retiring early" at age 60, but anticipates he might well need to cash in some of his IRA CDs before he hits FRA. Joe could maximize his IRA CD yields by purchasing a 5-year CD from, e.g., StateFarm, and pecking away at it as necessary during the term. Whatever Joe withdraws is done without penalty. The balance of the IRA CD clicks along at the stated rate.
If that's correct, it should be possible to do an IRA trustee-to-trustee transfer to another institution. This would avoid a lot of the issues that are inherent in receiving a check directly and having to do a rollover to another institution.
However, I've yet to find this in any of their disclosure agreements. If I can't find it anywhere, I'm going to send them a secure email so that I can get something in writing. We'll see how that plays out.
However, there's also one worrisome bit of wording in the disclosure.
" Unlike other financial institutions, members can take partial qualified distributions from their certificates without an early withdrawal penalty".
Exactly how does Pen Fed define a "qualified distribution"? Does the withdrawal have to be a check made-out to the IRA owner? Or, would an IRA trustee-to-trustee transfer be considered to be a "qualified distribution".
Since I'm already a member, I guess I could find-out by sending Pen Fed a secure email and insist on getting a written reply. The other way is just go ahead and try to do a IRA trustee-to-trustee transfer for a small amount of money and see if that flies.
The fine print.
f. Withdrawals: (1) Only you may request a withdrawal from your IRA certificates; beneficiaries have access to the account only upon your death. Funds are available for withdrawal on the business day following the maturity date. If the maturity date is a Sunday, funds will be available in two business days. (2) Partial withdrawals may be made, subject to early withdrawal penalties as described in paragraph (g) below, providing the requested withdrawal amount does not reduce the original issue below a minimum of $1,000 for 1-, 2-, 3-, 4-, 5-, or 7-year IRA Certificates, in which case the funds will be transferred to the IRA Share account. (3) The credit union reserves the right to require a written notice of up to 60 days of intention to withdraw funds from your IRA certificate(s). g. Penalties. In the event of early withdrawal, the following penalties apply: (1) If redeemed within the first year, all dividends will be forfeited. (2) If after the first year, but prior to the maturity date, the early withdrawal penalty will equal 30% of what would have been earned if the certificate had been held to maturity, not to exceed total dividends earned. (3) Exceptions. The penalties described above will not be applied if the withdrawal is made: (i) Subsequent to the death of any holder of the Certificate. (ii) As a result of the voluntary or involuntary liquidation of the credit union. (iii) If the owner is permanently disabled, as defined in the Internal Revenue Code Section 72(m). (iv) If the owner has reached age 59½ and takes a partial withdrawal.