CD Deals Summary
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Silicon Valley Bank Is Shut Down - Second Largest Bank Failure in HistoryCD 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.
ABZ (After Bernanke ZIRP) 100% interest paid out to supplement income.
Some banks and credit unions allow depositors to change how they like their interest treated after the account is opened. PenFed, for example, permits one to change where the interest goes at will, even making the choice online. While, in the case of Randolph-Brooks FCU, no changes are allowed after the account is opened.
Say, for example, that you found a 2yr Cd at 1.75%. If at all possible, you should direct the interest payments to be reinvested at that rate. If not, that money is probably going into a money market account where it will get ~.50%. So, every interest payment is losing a reinvestment rate of 1.25%, compared to the MMkt. until you find another attractive CD rate and accumulate sufficient funds to buy it. That difference adds up surprisingly quickly.
After I retired, I have the interest automatically withdrawn and transferred to my checking or savings account to augment my retirement income. (Compounding the pittance of interest earned today doesn't amount to much at all and is not missed.) Thanks to Bernanke!
Of course Greenspan didn't help matters either. His lying words still resonate in my ears today: "The crises in the housing market is well contained and will not spread to other sectors of the economy."
I personally have always taken the interest on a monthly basis to a MMA, yes I knew the differance, but I wanted the money as a suppliment to my income, after all this is why I use CD's at all anyway, I'm not saving for a house, college or whatever, I just use my savings to generate some added monthly income. It hasn't been any problem for me, I have also used it to just pay my estimated tax, so I didn't have one big bill later, anyway as I said its more a personal thing,, to each his own.
At this point in my life I don't need but so much to maintain my lifestyle, and by time I reach 75 I could care less what the interest rate is as I will start to just use up as much principle as I need too, I'll most likely not run out in the 10 to 15 years I would have left with my lifestyle.
Re Anonymous - #12, Tuesday, May 28, 2013 - 10:08 PM
I think your assumption that others are not in the same boat as you is flawed. Circumstances vary from one individual to another. Also, variables such as the total amounts and terms of the CDs and what other assets might be available to fund expenses are important to consider too. An extreme example: someone has assets totaling $100 million, all in CDs with maturities of 5, 10, 15 and 20 years. Unless someone else is going to pay the bills for the next 5 years until the next CD matures, they must take the interest to live on. But monthly interest on $100 million certainly buys a nice boat ;), which of course may/not be enough depending on one’s personal situation and choices.
For others, their choice might be to take a maturing CD out of a ladder, using it for living expenses and not reinvesting it so that others with better rates might continue to compound.
My point is that the decisions vary from one individual to another and how they handle interest on CDs is not necessarily an accurate indicator of which boat they are in.
My reason for taking the interest posted monthly is because all my CD's are opened at the max insurance level already, so any interest that sits in the CD is NOT covered, so I just move it to a MM where it may not get as much interest, but at least it gets something and its covered. Besides when that accumulates to any point I just move it again to another CU if necessary to use for another CD.