The Unbreakable CD Rule That’s Meant to Be Broken

early cd withdrawalWhile it’s usually not a good idea to break the terms of your bank accounts, there are some instances in which it might be beneficial to do so.

In fact, this could be a good move for your credit score, as you’ll see. Having said that, there are other agreements that should be honored no matter what.

Let’s first consider the circumstances in which you absolutely should break your agreements, particularly with certificates of deposit.

Early Withdrawal from a Certificate of Deposit

When you lock up your money in a CD you make a deal with the bank: They’ll pay you more interest than they would if you kept the money in your savings account while you, on the other hand, promise to keep the money on deposit for some period of time. If you don’t live up to your side of the bargain, they’ll penalize you with a CD early withdrawal penalty. This move will not hurt your good credit history, it will just compromise some of the yield you obtained a CD account for in the first place.

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How much is a CD early withdrawal penalty?

Typically, if you withdraw from your CD before it matures, the bank will ding you for interest they would have credited you otherwise. Of course, you have to check with your financial institution because the terms and conditions vary, but you might have to fork over three months’ interest if you prematurely withdraw from your one-year CD.

If you open a one-year CD today you might get a bit more than 1.00% APY for your trouble. So on a $100,000 deposit, you would earn a bit more than $1,000 in interest. If you break that CD and the penalty is three months’ interest, you’d be penalized a whopping $250.

Granted, you don’t want to throw away $250, but because interest rates are so low, you must realize that if you have a great opportunity to invest at higher rates, that penalty shouldn’t be an obstacle.

What kind of opportunities are worth it?

From a purely financial angle, anytime you can earn a significantly higher return on your money, it would be smart to break your CD and reinvest in a higher-paying alternative so long as the greater yield makes up for incurred penalties.

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For example, let’s say you change your investment goals and are ready to invest for long-term growth through a mutual fund or the stock market. You don’t know for certain that you’ll earn more than the CD would yield in any one year, but in the long run you feel confident that you will. In this case, you should break that CD.

Another example would be if you have a great opportunity to be in business for yourself and you need the CD money to launch your dream. Assuming you have a solid business plan, you might choose to move forward with that goal and repossess some of the funds you’ve locked into a CD.

Finally, you should absolutely break a CD if you are in debt. It makes no sense to earn 1.00% APY and pay 6.00% APR or more on a credit card balance. Such a move could help you keep your credit score in good standing.

Related: Want the Best CD Rates? Find the Best Early Withdrawal Penalties

When should you avoid a CD early withdrawal penalty?

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If you want to tap into your CD in order to pay for your lifestyle, you might want to reconsider. If your spending is out of control, a CD could be a useful tool to help curb your spending habits; the penalty can act as an incentive for you to keep saving.

Your most important mission, if this is your situation, is to get your spending in line with your income. Once you get a firm handle on your spending it might make sense to break the CD to pay off credit card debt as mentioned above. But it almost never makes sense to spend down your savings in order to pay for your daily, monthly or annual living expenses.

What about retirement accounts like a 401(k)? Should you break the terms of those accounts?

It’s suggested that you never take money out of your retirement accounts except for extreme circumstances, like a medical emergency or the potential loss of your home. Yes, there are usually provisions for making an 401(k) early withdrawal, but you should not take advantage of those rules. Here’s why:

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If you need money to invest in a business, you should be pretty good at budgeting before you open your doors — that means you should have money saved outside of your retirement accounts. If you don’t have significant savings, it probably indicates that you need to get your finances in order before you become self employed.

In terms of higher-paying investments, most retirement plans offer a wide variety of investment choices. You shouldn’t have any trouble finding great alternatives without pulling money out of your retirement account and incurring taxes and penalties.

And if you’ve run up debt, you should be even more hesitant to use retirement assets to cover what you owe. You must be absolutely sure that you have solved your spending problem before you invade your retirement account. If you don’t, you’ll simply spend your way through your it and end up with no resources both now and in the future.

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About the Author

Neal Frankle

Neal Frankle, Certified Financial Planner (r) launched Wealth Pilgrim in 2009 in response to the financial turmoil that resulted from the economic crisis of 2008.

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