This CD Hack Could Help You Avoid an Early Withdrawal Penalty

One of the nicest things about having money in the bank is that you basically get a risk-free return. Of course, this assumes your bank is FDIC-insured, and you're limiting your deposit to $250,000 (or $500,000 with a joint depositor). But frankly, both of these rules are pretty easy to follow.

However, it's not totally true that you're getting a risk-free return on your money in the context of a CD. Technically, your principal is protected. But in exchange for a guaranteed interest rate on your money, CDs require you to commit to keeping your money where it is for a preset period. And if you cash out a CD before its maturity date, you could be hit with a costly early withdrawal penalty.

That penalty will depend on the bank you're using and the term of your CD. At some banks, for example, you'll face a penalty of three months of interest if you take an early withdrawal from a CD with a term of 12 months or less. You'll need to check your bank's CD disclosures to see what specific penalty you risk for an early withdrawal.

But the good news is that there's an easy way to lower your risk of an early CD withdrawal penalty. And no, it's not keeping your money in a savings account instead. Rather, it's being strategic about how you open and manage your CDs.

Our Picks for the Best High-Yield Savings Accounts of 2024

Capital One 360 Performance Savings APY 4.25% Rate info See Capital One website for most up-to-date rates. Advertised Annual Percentage Yield (APY) is variable and accurate as of April 11, 2024. Rates are subject to change at any time before or after account opening. Min. to earn $0 Open Account for Capital One 360 Performance Savings Member FDIC.	APY 4.25% Rate info See Capital One website for most up-to-date rates. Advertised Annual Percentage Yield (APY) is variable and accurate as of April 11, 2024. Rates are subject to change at any time before or after account opening.	Min. to earn $0
American Express® High Yield Savings APY 4.25% Rate info 4.25% annual percentage yield as of July 3, 2024 Min. to earn $1 Open Account for American Express® High Yield Savings Member FDIC.	APY 4.25% Rate info 4.25% annual percentage yield as of July 3, 2024	Min. to earn $1
Citizens Access® Savings APY 4.50% Min. to earn $0.01 Open Account for Citizens Access® Savings Member FDIC.	APY 4.50%	Min. to earn $0.01

A CD ladder could help you avoid an unwanted penalty

A lot of people are trying to capitalize on today's great CD rates. And you may be eager to do the same.

But if you put all of your spare money into a single CD, you might end up in a situation where you have to take an early withdrawal. That's why a CD ladder could be a much better option.

With a CD ladder, instead of opening one CD, you take your money and split it up across different CDs with varying maturity dates. If you have $10,000 to put into CDs, you might open a 3-month CD with $2,500, a 6-month CD with $2,500, a 9-month CD with $2,500, and a 12-month CD with your final $2,500.

This way, you have part of your cash freeing up every three months. If you end up having a need for that money, you might gain access to it before an early CD withdrawal penalty comes into play.

You might also decide to play around with some longer CD terms. In the example above, if you want four CDs, you may decide to choose terms of six months, 12 months, 18 months, and 24 months. There's no rule saying that some of your money has to be freed up every three months.

The point, however, is to not lock all of your money up in a single CD with a single maturity date.

Think carefully before opening a CD

A CD ladder can lower your risk of facing an early withdrawal penalty to some degree. But another step you can take to avoid a penalty like that is to think carefully before opening a CD (or several CDs) in the first place.

The $10,000 we talked about in the example above? You'll want to make sure it's on top of money you might need for emergencies or other unplanned expenses. And you'll also want to think about whether you have any near-term repairs or larger bills you might have to cover, whether it's your water heater that seems to be on the fritz or your quarterly property tax bill.

CDs are awesome in that you can earn a higher interest rate on your money and have that rate guaranteed for a set period of time -- something a savings account can't offer. But avoiding an early withdrawal penalty is the best way to make the most of CDs. So do whatever you can to steer clear of one.