What Happens If You Take Money Out of a CD Early?

A Certificate of Deposit (CD) is a savings product where funds are deposited for a fixed period, such as six months, one year, or five years, in exchange for a specific interest rate. Financial institutions typically offer higher interest rates on CDs compared to standard savings accounts, rewarding depositors for committing their money for a set duration. Accessing these funds before maturity typically carries financial consequences.

Understanding Early Withdrawal Penalties

Financial institutions impose early withdrawal penalties on Certificates of Deposit to discourage depositors from breaking their agreement to keep funds locked up for the full term. These penalties help compensate the bank for potential loss of anticipated interest income and administrative costs. Penalties often involve forfeiting a certain number of months’ worth of interest, typically three to twelve months, depending on the CD’s original term.

The penalty is usually applied against interest already earned. If accrued interest is less than the penalty, the difference may be deducted from the original principal, potentially resulting in receiving less than the initial deposit. The specific terms for these penalties are always outlined in the CD agreement.

Calculating the Penalty Amount

Calculating an early withdrawal penalty depends on the specific terms outlined in your CD agreement, which typically specify a forfeiture period based on the CD’s original term. For instance, a common penalty for a one-year CD might be three months of simple interest, while a five-year CD could carry a penalty of six months of simple interest.

To determine the exact penalty, multiply the annual interest rate by the principal amount and then divide by twelve to find the monthly interest. This monthly interest figure is then multiplied by the number of months specified in the penalty clause.

For example, a $10,000 CD with a 2.00% annual interest rate and a six-month simple interest penalty would first yield $200 in annual interest ($10,000 0.02). The monthly interest is $16.67 ($200 / 12).

Multiplying this by the six-month penalty period results in a $100.02 early withdrawal penalty, which is deducted from your payout. Some institutions might calculate the penalty based on the interest rate at the time of withdrawal, which could differ from the original rate.

Situations Where Penalties May Be Waived

While early withdrawal penalties are standard for Certificates of Deposit, there are specific circumstances where financial institutions may waive or reduce these fees. One common scenario for a penalty waiver is the death of the CD owner, allowing beneficiaries to access the funds without penalty upon presenting proper documentation like a death certificate. Similarly, if the CD owner is declared legally incompetent, the appointed guardian may be able to withdraw funds without penalty, typically requiring court orders or similar legal documentation.

For CDs held within an Individual Retirement Account (IRA), an exception applies when the account holder reaches age 59½. Withdrawals from an IRA CD after this age are generally exempt from early withdrawal penalties imposed by the financial institution, though ordinary income taxes will still apply to the distributed amounts. However, if funds are withdrawn from an IRA CD before age 59½, they may be subject to a 10% early distribution tax by the Internal Revenue Service (IRS), in addition to the bank’s early withdrawal penalty.

Some financial products, known as “no-penalty CDs” or “liquid CDs,” are specifically designed to allow early withdrawals without penalty. These often come with lower interest rates to compensate the bank for the added flexibility.

Steps to Initiate an Early Withdrawal

Initiating an early withdrawal from a Certificate of Deposit requires direct communication with your financial institution. The first step involves contacting your bank or credit union, which can typically be done in person at a branch, over the phone, or sometimes through secure online banking portals. You will need to clearly state your intention to withdraw funds from your CD before its maturity date.

The institution will then guide you through their specific process, which usually includes verifying your identity. This verification typically requires presenting a valid government-issued identification, such as a driver’s license or passport, and providing your CD account details.

You may be asked to complete and sign specific withdrawal forms or agreements acknowledging the early withdrawal and the associated penalties. Once all necessary documentation is completed and verified, the bank will process the withdrawal, deducting any applicable penalties before disbursing the remaining funds to your designated account or by check.