CD Interest: Let It Accumulate or Receive Regular Payments?

Most banks and credit unions give CD customers at least two choices when they open a CD. First, they can choose to let the interest accumulate in the CD, or second, they can choose to have the interest be paid out on a regular interval during the CD term. If you typically use the interest from your CDs to supplement your income, you probably always choose the second option.

For today’s poll, what option do you typically choose for your non-IRA CDs? Do you choose to let the interest accumulate in your CD? Or do you typically choose to have interest paid out to you in regular intervals?

One downside with withdrawing the interest from your CDs is that this will reduce the annual percentage yield (APY). This is due to the fact that you lose the advantage of compounding. The interest rate is only being applied to the principal and not principal and interest.

One advantage of withdrawing the interest from your CDs is that you can use part of that interest to pay taxes. If your non-IRA CD has interest that accumulates, you will generally still owe taxes on that interest that is credited during the tax year even if the interest isn’t paid out to you (see post on CD and taxes).

Every now and then we come across a bank that doesn’t allow interest to be paid out. That was originally the case at Barclays. For the first year it did not allow interest disbursements, but as I reported earlier this month "you can receive an interest disbursement from your CD account on a monthly basis. You have the option to keep interest in your CD account or transfer it to your Barclays Online Savings account or a verified external account."

Frequency of CD Interest Payouts

Some banks and credit unions give the customer many options about the frequency of the interest payments. As you can see above, Barclays pays out its interest monthly. Ally Bank allows CD customers to choose the payouts to be on a "monthly, quarterly, semi-annual or annual basis."

The frequency is often based on how the institution credits the interest. If interest is credited monthly, then the interest can be paid out monthly. That’s the case of Mountain America Credit Union. According to MACU’s truth in savings document, "at the time of opening, you may request to have dividends paid to you by check, transferred to another share or to a different account monthly rather than credited to this term deposit account." Melrose Credit Union credits interest quarterly, so the payouts will also be quarterly. According Melrose Credit Union’s website "members will still have the option of having their quarterly dividend transferred to another share account."

Withdrawal of Accrued Interest

If you opened a CD and specified that the interest accumulate in the CD, you may be allowed to withdraw the accrued interest in the future without an early withdrawal penalty. This can be useful if you need some money, but you don’t need any of the CD principal. It can also be useful if interest rates go up. Some banks like Nationwide Bank specifically allow this in their disclosure:

You can only withdraw interest credited in the term before maturity of that term without penalty. You can withdraw interest any time during the term of crediting after it is credited to your account.

Of course, there’s always a concern that a bank may change its policies regarding early withdrawals, even early withdrawals that don’t include any of the principal. The risks of an institution making retroactive changes to CDs have been seen at credit unions which have raised the early withdrawal penalties on existing CDs. I have more details in this blog post.