When you open a CD, it can be difficult to understand the details of the CD's early withdrawal penalties. Banks and credit unions often don't make it easy. The rate tables often only include the warning that early withdrawals may be subject to a penalty. One important thing to note is that the penalty is up to the bank or credit union. The size of the penalty and other details about the penalty can vary greatly for different banks. To understand these details, you'll need to review the CD disclosure. Here are some of the basic features and issues of the early withdrawal penalty to review in the disclosure.
Early Withdrawal Penalty Size
The obvious feature is the size of the penalty. This is typically specified in the number of days or months of interest. For maturities over one year, a penalty of 6 months of interest is common. So if you make an early withdrawal at exactly 6 months after you open the CD, you'll lose all 6 months of the interest. If you close the CD after one year, you'll lose half of the accrued interest.
The penalty size isn't always this simple. Here's what EverBank includes in its disclosure:
This penalty will be equal to one-fourth of the total interest that would have been earned on the principal balance of the account if funds had not been withdrawn prior to the maturity date.
For a 60-month CD, one-fourth of the total interest would be equal to 15 months. As you can see, this is much more severe than 6 months.
The complexity is often even worse. Here's what US Bank includes in its disclosure:
If your account has an original maturity greater than one year, the penalty will be the greater of either A or B, plus a $25 early withdrawal fee.
A. One-half of the interest that would have been earned on the funds withdrawn if held for the entire term.
B. 3% of the amount withdrawn.
In this case, the penalty will be at least as big as one-half of all the potential interest that can be earned. For a 60-month CD, that's 30 months of interest.
Some of the Principal Can Be Lost
What happens if you close a CD just a couple of months after you opened the CD? Can you lose some of your principal? Yes, it is possible that the penalty will eat into your principal. It depends on the bank or credit union. A few institutions won't eat into your principal. PenFed is one example. Here's what PenFed's disclosure describes:
Certificates with a term of 5 years or greater
If redeemed within 365 days of the issue date or any renewal date, all dividends will be forfeited.
If redeemed thereafter, but before the maturity date, dividends for the most recent 365 days will be forfeited.
So if you close the PenFed CD very early, you'll just lose all of the interest but none of the principal.
From my experience, PenFed is in the minority on this penalty feature. Most institutions don't provide any reduction of the penalty if closed very early. So if you close the CD 3 months after you opened the CD and the penalty is 6 months of interest, you'll not only lose all 3 months of accrued interest, but also you'll lose some of your principal equal to 3 months of interest.
Some institutions point out this feature in the disclosure. For example, Fort Knox Federal Credit Union has the following in its disclosure:
the owner shall forfeit an amount equal to 180 days dividends whether earned or not on certificates with maturities greater than 24 months.
So if you close the CD before you have earned 180 days of dividends (interest), you'll still lose 180 days of dividends.
Partial Withdrawals and Withdrawals of Interest
If you need some of the CD money, you sometimes have more options than just closing the entire CD. One option may be to just withdraw some of the accrued interest. Some banks like Nationwide 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.
If the accrued interest isn't enough, you can then take out some of the principal. Many banks will allow a partial withdrawal of principal, and the penalty will only be based on the amount of the principal that was withdrawn.
Some banks don't allow partial withdrawals. One notable example is Ally Bank. Here's what Ally includes in its disclosure:
You may not make a partial withdrawal of funds you deposit in a CD prior to the maturity date. If you withdraw all of the funds you have deposited in a CD prior to the maturity date, we will close your CD, add the accrued interest to date to the balance and impose a penalty on your early withdrawal.
Bank Refuses an Early Withdrawal Request
It's bad enough that you will lose some interest, but it's possible that a bank can refuse the early withdrawal request. Some banks give themselves this right to refuse an early withdrawal in their disclosures. Here's what is specified in US Bank's disclosure:
Except as required by law, withdrawal prior to maturity will be permitted only with the consent of the bank which may only be given at the time of withdrawal.
Fort Knox Federal Credit Union also has a similar clause in their disclosure:
Withdrawal of the principal amount of your Certificate may be made only with the consent of the Credit Union
Not all banks and credit unions have this type of clause. Some clearly state in the disclosure that early withdrawals are allowed. Nationwide Bank's disclosure is one example:
You may make withdrawals of principal from your account before maturity. Principal withdrawn before maturity is included in the amount subject to early withdrawal penalty.
Early Withdrawal Penalty Changes
Another potential issue is if the bank decides to increase the early withdrawal penalty during the term of your CD. Such a change would be very unusual, but some banks include a clause in their disclosures that may give them a right to make such changes. For example, Capital One Bank has the following in its direct banking CD agreement:
We have the right to change this agreement, including fees and charges applicable to the CD, at any time. These changes may include the addition of new charges or terms. If we make changes, you will be notified as required by applicable law.
Most banks don't make it clear about their right to make changes to existing CDs, and as we've discussed in November, the risk of this happening is not clear.
One reader commented that BB&T changed its early withdrawal penalties on an existing CD. However, as one reader explained, this could be considered an immaterial change due to its very small impact.
If inflation and interest rates do rise substantially, there will be much more attention paid to early withdrawal penalties of CDs. Once a CD is opened, there's not much that can be done. The time to review the early withdrawal penalty features is before the CD is opened.
Edit 3/29/2011: Changed Fort Knox FCU disclosure to a newer version.
Edit 4/08/2011: Changed PenFed's disclosure to a newer version.