What Is a CD Early Withdrawal Penalty?

What Is a CD Early Withdrawal Penalty?

A certificate of deposit is a type of low-risk savings account that requires you to keep your money in the account for a set period of time. If you cash out before the CD matures, you'll likely pay an early withdrawal penalty.

Early withdrawal penalties are typically calculated in a number of days or months of lost interest gains.

Federal law sets a minimum penalty for taking your cash out early. Withdrawals made within the first week of your initial deposit are typically subject to at least seven days' worth of interest earned. But there's no legal cap on penalties, so how much you'll owe after an early withdrawal depends on your account terms.

Learn more: Are CDs Worth It?

How Much Does a CD Early Withdrawal Penalty Cost?

CD early withdrawal penalties vary widely, depending on the bank or credit union. But generally speaking, you'll lose the equivalent amount of interest earned for a set number of days or months. Some financial institutions may also charge a small fee. CD early withdrawal penalty costs may be listed online or in the fine print in the terms of the CD agreement.

Here's a look at what penalties look like at some of the largest banks:

How to Calculate an Early Withdrawal Penalty for a CD

To calculate a CD's early withdrawal penalty, you'll need to know:

• The penalty for the CD term
• How interest compounds (daily or monthly)
• Whether the penalty is based on the entire balance or on the withdrawal amount

Then, apply the formula below (using balance amount in this example) to determine the penalty for making a withdrawal before the CD term ends:

Example: You have $10,000 in a one-year CD with a 4% annual percentage yield (APY), and your bank charges an early withdrawal penalty of 90 days' interest. Using the formula, you can expect to pay a penalty of roughly $123.

• $10,000 x (.04/365) x 90 = $123.29

Learn more: Types of CDs and How They Work

How to Avoid CD Early Withdrawal Penalties

If you don't want to pay a CD early withdrawal penalty, you have several options:

• Don't withdraw money early. Waiting until the CD matures is the best way to avoid paying an early withdrawal penalty. If you don't want your money tied up for too long, you can choose a CD with a short term, like three months.
• Get a no-penalty CD. No-penalty CDs typically allow a one-time withdrawal at least one week after the initial deposit without paying a penalty. But you may have to meet certain conditions, like keeping a minimum balance in the account.
• Consider CD laddering. Split your investment across a few different CDs with varying terms to access cash sooner without paying a penalty. Instead of opening one CD worth $9,000, for example, you open three CDs for $3,000 each—one with a three-month term, one with a six-month term and one with a nine-month term. When each CD matures, you can withdraw the cash or reinvest it into another CD.
• Get a brokered CD. Brokered CDs are sold through a third party, like a brokerage firm. They typically don't have early withdrawal penalties, and you may be able to sell your CD on the secondary market.
• Use the CD barbell approach. The purpose of a CD barbell is to put half your money in a short-term CD and half in a long-term CD. Doing this allows you to access half your money sooner, while the other half of your investment often benefits from higher interest in a longer-term account.
• Start an emergency fund. Setting some money aside for unexpected expenses in a savings account that doesn't hit you with penalties, like a high-yield savings account, can help you avoid tapping into your CD early.

Are CD Early Withdrawal Penalties Tax Deductible?

Early withdrawals from a standard CD can have tax implications. Generally, you must report any interest earned on a CD when you file your taxes. So if you take out money before your CD matures, you'll still need to pay taxes on the interest earned before the early withdrawal.

But you can also deduct early withdrawal penalties from your taxable income, which could help reduce the amount you owe. Deductions can be subject to some limitations. So if you make an early withdrawal, it's a good idea to check with a tax professional to make sure you file your return correctly.

Learn more: How Are CDs Taxed?

The Bottom Line

A certificate of deposit is generally a low-risk investment that can provide stable returns—as long as you can leave your money alone until the CD matures. If you need access to your cash before the CD's term is up, you'll not only lose out on potential interest, but you'll likely have to pay an early withdrawal fee too.

To maximize your return and reduce your chances of taking money out early, choose a deposit amount you're comfortable being without for a period of time and shop around to find a CD with terms that fit your financial goals.