If you locked in a certificate of deposit or CD last year, you may be missing out on a bigger return.
Some online-only banks are offering over 5.00% APY right now for short-term CDs, while longer terms are around 4%. But with year-over-year inflation slowing to 3% and the Federal Open Market Committee meeting next week, experts predict CD rates will start dropping later this year. But while rates remain high, is it worth it to break an existing CD?
“The decision to break a CD before its maturity date is akin to deciding whether to leave a party early,” said James Allen, CFP and founder of Billpin. “You might have a good reason, but you’ll miss out on some of the fun.” While breaking a CD for another higher rate CD may help you capitalize on even better interest rates, there’s a cost to consider. While you’ll miss out on interest for the remainder of the term, if you can lock in a higher rate, this is probably beneficial. But consider if your CD has an early withdrawal penalty, and how much interest you’ll need to pay, to see if a new CD rate can help you earn a big enough return to justify paying the penalty.
We spoke with the experts to find out everything you need to know before breaking a CD to get a better return before rates drop.
Should you withdraw early from a CD to take advantage of higher rates?
To decide if it’s worthwhile, compare the early withdrawal penalty from your current CD. If the interest on the new CD for that timeframe is higher than the fees you’d pay, you’re good to go. But if your return is less than the withdrawal penalty you’ll pay, waiting until your current CD term ends might be better to avoid losing money.
For example, if you opened a one-year CD last December when rates were lower, and you want to break the CD in August, you’ll miss out on approximately four months’ worth of interest.
By the numbers, let’s say you put $1,000 in your one-year CD had an APY of 3.35% and now you’re seeing rates as high as 5.05% APY for the same term. The withdrawal penalty for your current CD is six months of interest. Here’s the breakdown.
- You’ll forfeit $16.48 in interest, leaving your balance to be $1005.70. If you left the money in the CD for the full term, you’d earn $1,033.50.
- If you keep the money in the new CD for the entire year, you’ll earn $1,050.50.
- In this case, it’s best to break the CD and earn a bigger return at the new rate.
But remember there are other options if you contact your bank, too. “Consider other options like negotiating with the bank for a lower penalty or transferring the funds to a different account,” said Allen. “It’s like trying to change your flight; sometimes, there are better options than just canceling.”
When should you break a CD early?
The key factors you should consider before taking money out of your CD early are the penalty for early withdrawal, the potential gains from the alternative investment you’re considering and your immediate need for cash, said Allen. But withdrawing early from a CD almost never makes sense unless you find yourself in one of these two situations:
- You have an emergency expense: If you’re in a tight spot with your finances or debt, you may not have any other choice but to withdraw from a CD account early, regardless of the penalty.
- You can make more money with another CD or investment: When you open a CD, you lock in a fixed annual percentage yield for a set period of time. This means if interest rates rise, your CD account may no longer earn a competitive yield. If rates rise high enough, it may be worth withdrawing your money early to secure a higher rate with another CD or savings account.
Before you break your CD, make sure there aren’t any other funds you have set aside that could help you avoid paying the penalty.
The cost of withdrawing from your CD early
When you put your money in a CD, you’re making an agreement with a financial institution to keep it there until it reaches maturity. When you withdraw before the end of the CD term, you’ll usually need to pay an early withdrawal penalty.
There isn’t a standard early-withdrawal penalty fee across all financial institutions; how much you will owe depends on the bank, your CD term and how soon you withdraw your money. Generally, the longer the CD term, the larger the penalty.
“It’s going to vary [from] institution to institution, but typically it’s a simple mathematical calculation based on the timeline of the withdrawal relative to the initial commitment of time,” said Paul Gaudio, a certified financial planner at Bryn Mawr Trust.
In most cases, you’ll get back your initial investment -- but forfeit some interest. Sometimes, particularly when you withdraw very early into a term, an early withdrawal penalty can cost more than the interest earned, and you could lose some of your principal. For example, if a bank charges you 180 days worth of interest, but you withdraw your money 90 days after opening an account, then you’ll likely need to sacrifice some of your principal investment to pay the penalty.
Lastly, beware of tax implications, said Allen. “The interest earned on the CD is taxable, and if you withdraw it early, you’ll have to report that income sooner.” For example, if you opened a three-year CD last year but you withdraw from it this year, you’ll need to report the interest you earned next year, during tax season.
Alternatives to breaking a CD early
If you’re on the fence about where savings and CD rates will go, you could consider more flexible savings options. Although not all of these options offer the highest APYs, you may have easier access to your money without worrying about an early withdrawal penalty. Here are a few alternatives:
No-penalty CDs
No-penalty CDs let you withdraw money without incurring a penalty. You can typically withdraw your funds after one week of opening your account. However, there are some requirements that vary across banks. For example, you may have to withdraw your full balance, rather than pulling out a portion of your money.
“This can be a good option if you think interest rates may fall and you want the flexibility to move your money to a higher-yielding investment if rates decrease,” said Doug Carey, the founder and president of WealthTrace. “However, no-penalty CDs typically offer lower rates than traditional CDs, so you may sacrifice some potential earnings for the flexibility.”
CD ladder
A CD ladder is a more flexible savings strategy than just purchasing a long-term CD. The idea is to spread your deposit across multiple CDs with different terms, so your money comes due more frequently, allowing you quicker access to then use the funds or reinvest them in another CD.
“If rates do increase, when your shortest CD matures, you get to reinvest at the higher rates,” said Kirill Semenov, certified financial planner and wealth advisor at Intellicapital. “If rates drop, a ladder is better than just one short-term CD…you will get some boost from the longer-maturity ones.” Plus, you’ll periodically get access to your money while maximizing your interest, he added.
High-yield savings account
A high-yield savings account is the most flexible option if there’s a chance you may need funds on a whim. For instance, a high-yield savings account is a great place to hold your emergency fund, savings for car repairs or other goals you might need easily accessible. Right now, you can earn a high savings rate that’s on par with some short-term CDs. However, high-yield savings accounts have a variable rate that increases or decreases depending on the bank and economic conditions. So you won’t be able to calculate how much interest you’ll earn during a timeframe.
But the main benefit of this account is its easy access. While most CDs require you to fund the CD in full at the time of account opening and may charge an early withdrawal penalty for withdrawing before the term expires, a savings account let’s you withdraw and deposit funds as you need.
The bottom line
A CD offers a low-risk way to earn a fixed-return on your money. And right now, CD rates are better than they’ve been in recent years. You can earn a decent return -- even with shorter terms. If you’re considering closing a CD early to take advantage of a better rate, first calculate how much interest you’ll miss out on and how much you’ll have to pay. Sometimes, it’s better to wait for the CD to mature. In the meantime, you can set aside more money in a savings account to invest in a CD down the road if rates are still up. Before investing in a new CD, remember that if there’s a chance you’ll need the money, there are other options that offer flexibility and interest, too.
This article includes some material that was previously published on NextAdvisor, a CNET Money sister site that was also owned by Red Ventures and which has merged with CNET Money. It has been edited and updated by CNET Money editors.
Correction: An earlier version of this article was assisted by an AI engine and it mischaracterized some aspects of savings accounts. Those points were all corrected. This version has been substantially updated by a staff writer.
