If you have a sizable amount in your Ally Bank Online Savings Account and you want to keep it liquid, opening one or more 11-month No Penalty CDs with some of this money is an easy way to earn more interest. If the Online Savings Account rate goes down this year, the No Penalty CD will provide an even larger interest rate premium. If the Online Savings Account rate goes up and exceeds the No Penalty CD rate, you can just close the No Penalty CD. Ally Bank makes it very easy and quick to close a No Penalty CD and transfer the money into your Ally Online Savings Account. I consider the No Penalty CD a savings account rate booster rather than a CD.
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Shifting Taxable Income Into the Next Tax Year
There’s another reason to consider the Ally 11-month No Penalty CD besides to earn more interest. It allows you to shift taxable income into the next tax year. This was recently discussed in this DA Forum post.
For CDs with terms of 12 months or less, Ally Bank will credit interest earned at maturity, unless you choose another interest payment option (i.e. monthly or quarterly). If you open the 11-month No Penalty CD after January and you choose the default option of letting Ally credit interest earned at maturity, no interest will be earned for the current tax year. Thus, no interest from the No Penalty CD will be included on the 1099-INT that you'll receive next January. If you just keep the money in the Online Savings Account rather than using it to fund a No Penalty CD, interest will be credited each month. Thus, this savings account interest will be listed on the 1099-INT that you’ll receive next January.
IRS Rules on CD Interest
The IRS rules on CD interest are detailed in IRS Publication 550. The following paragraph is from the section on “Interest Income” in Chapter 1:
Certificates of deposit and other deferred interest accounts. If you buy a certificate of deposit or open a deferred interest account, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.
I first noted this paragraph in my 2011 post on CD interest and taxes. When I reread the above excerpt from Publication 550, I was concerned about the following sentence and how this relates to the No Penalty CD:
You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty.
Are you “entitled to receive” interest from your No Penalty CD “without paying a substantial penalty”? Obviously, you’re entitled to close the No Penalty CD after six days of account funding without a penalty. At that time, you will receive the interest. However, you’re not entitled to receive interest if you do not close the No Penalty CD. Thus, if your No Penalty CD is set up so that interest is only paid at maturity and you keep the CD opened, you neither receive the interest nor are you entitled to receive the interest.
The above interpretation must be how Ally is interpreting this IRS rule since Ally is not including uncredited interest on 11-month No Penalty CDs in their 1099-INTs. I can confirm that on my 1099-INT. I opened an Ally No Penalty CD last August with interest to be credited at maturity. My 2019 1099-INT from Ally did not include any interest from this No Penalty CD.
When Tax Shifting Won’t Work
Of course, this shifting of taxable income into the next year won’t work if you choose an early closure of the No Penalty CD during the current tax year. You won’t lose any accrued interest, but all of that interest will be credited at the closure of the CD.
Also, this tax shifting may not work at other online banks that offer no-penalty CDs. I’ve reviewed the disclosures of several of these online banks, and all specify that interest earned will be credited monthly on their CDs.
Tax Shifting with Other Ally CDs
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This tax shifting also works with Ally’s 12-, 9-, 6- and 3-month High Yield CDs. The 12-month CD currently offers a rate that’s 10 bps higher than the top-tier rate of the 11-month No Penalty CD. So if you’re not concerned about liquidity, you may choose the 12-month over the 11-month. Don’t forget that the early withdrawal penalty on Ally’s CDs with terms of 24 months and under is only 60 days of interest.
I don’t see any reason to choose Ally’s 3-, 6- or 9-month CDs. All have a history of rates that have been much lower than the Online Savings Account rates. There is one reason why you may want the 3-month CD. By having a CD ladder of 3-month CDs, it makes it easy to take advantage of Ally’s 0.05% Loyalty Reward. This strategy is detailed in this DA Forum post.
This article contains general tax information and should not be considered tax advice. If you have a question about your taxes, and what should be reported on them, it is a good idea to consult a tax professional who can help you navigate the rules.