If you want anything close to a decent yield today that's safe and without balance caps and hassles (i.e. reward checking), a long-term CD is the only option. Most internet savings accounts and short-term CDs have yields under 1.50%. On the other hand, several long-term CDs have yields from 3.00% to close to 4.00%. The main concern with long-term CDs is being stuck in the CD if interest rates and inflation shoot up. However, if the CD's early withdrawal penalty is mild, this risk may be smaller than you think.
I've recently been posting on some long-term CD deals. The latest includes those from PenFed and Ally Bank. Allan Roth at The Irrational Investor Blog at MoneyWatch described these deals in a recent blog post. He suggests "Reframing the way you think of a long-term CD":
So don’t think of this as a seven year CD. Think of it as a two year CD that pays as high as any two-year CD, and that also gives you this free option to earn much more after two years, as well as a possible one-time bonus after seven years.
Also, he notes why these deals aren't getting the publicity they deserve:
These great CDs exist because no one has the incentive to tell you about them. They don’t pay commissions, and any planner charging a percentage of assets can’t use these vehicles to get their take.
We are actually fortunate that they're not getting the publicity. Otherwise, the rates may be falling much faster. But more people may be learning about these, and this may be why we have seen some big recent rate drops.
Allan provides the early withdrawal yield table for PenFed, Ally Bank, Discover Bank and USAA Bank that are similar to my tables for Discover Bank and PenFed and Ally Bank. I think his yield calculations are a little more accurate. As I've mentioned, I have just used a quick approximation method to determine the yields. Nevertheless, his numbers are close to mine.
The Best Deal is at USAA Bank But There's a Potential Gotcha
As you can see in Allan's table, the best deal for year 3 to 7 is USAA Bank's 7-year Super Jumbo CD which has a 3.92% APY as of 9/02/2010.
One potential gotcha with USAA Bank is the possibility that the bank may refuse an early withdrawal request. As I mentioned in my latest USAA Bank CD review, the CD disclosure does give them this right:
Any withdrawals before the maturity date require Bank’s consent
One of Allan's commenters also had this concern. Here was Allan's reply:
I'm not an attorney but I think if the agreement gives you the right to withdraw with the stated penalty, you have that right. I confirmed with all four financial institutions.
The USAA agreement did note they had the right not to honor such a request. The written response from USAA was as follows:
"Keeping its members' financial needs in mind, USAA would continue to honor early withdrawals for the balance of a CD after an offset (due to monies owed to USAA) or lien has been applied."
As noted in the blog - ALWAYS read the disclosure and don't assume any language. Many years ago I wrote about this strategy at Capital One. As a result of my article (I'm pretty sure), they changed the withdrawal penalty but could only do it for new accounts.
There's also a concern that the bank may increase the penalty on existing CDs. As Allan described, banks should only make penalty changes on new CDs and not existing CDs. I've looked into these early withdrawal penalty concerns many times for Ally Bank's CD and for long-term CDs in general.