It’s not easy to grow your savings. If you’re like most Americans, earning the highest interest rate on your deposit accounts would be very helpful this year. But in Bankrate’s recent Emergency Savings Survey, most Americans say they have less emergency savings now than they did at the beginning of 2024.
Previously, in Part 1 of this article, I covered how certificates of deposit (CDs) can help you grow your savings, even for emergency or rainy-day funds. Many people know CDs typically offer higher rates compared with other deposit products such as savings and money market accounts. Traditionally, though, fewer people use CDs for emergency funds because they typically impose penalties for withdrawal before maturity, often at the cost of interest and possibly even some loss of principal.
As long as you understand your options, you can harness your CD’s higher interest. In Part 1, I covered why you should treat a CD’s early withdrawal penalty as an exit option with a cost and how it benefits you as a saver. This article will cover additional options available when withdrawing CD funds before maturity. Again, the goal is to enable you to earn higher CD interest rates on more of your savings.
So, what other options do CDs have aside from early withdrawal?
Options available at origination
Depositors who haven’t used CDs often, or who have never had to withdraw funds early, generally focus on the so-called early withdrawal penalty. They may even reluctantly take the withdrawal penalty when they need their funds, typically losing 90 or 180 days’ worth of interest when it could’ve been avoided using the CD’s options.
All deposit products provide at least two types of built-in optionality: an option when you open an account, or certificate, and options while using them.
CD laddering
The first way to prevent having a penalty is available to you when you open a CD; it’s called laddering. Instead of opening just one CD, you can break up your savings into smaller amounts and invest them in a basket of CDs with various maturities all fitted to your financial plan. If you divide your savings into quarters, you may decide one quarter will stay in a savings or money market account. Then, you’d invest the second quarter in a CD for three months, the next for six and then for 11 months.
My example is genuinely just that – an example. Yours would have terms based on your risk appetite and financial planning. Some depositors prefer that the last 25 percent of their savings remain invested for longer than 11 or 12 months, depending on the CD rates and terms available, because it generates more interest. In that case, they don’t plan to touch that money unless they have a significant emergency.
Selecting a shorter-term CD protects you from the prospect of having to withdraw your funds (and be charged a penalty), while selecting a longer-term CD typically pays more interest. So, how do you forecast your penalty in that significant emergency scenario? That will make it easier to decide how long of a CD term you want. It also helps to consider partial withdrawal. Let’s look at both these elements.
Partial withdrawal options
Sometimes, you can’t avoid withdrawing funds from a CD, even if you have laddered your savings into different terms. During a significant emergency, you may need funds inside your CDs but you don’t necessarily need to close the CD.
In this case, you can engage your bank or credit union about a partial withdrawal for the amount you need for your emergency. This can benefit you in two ways:
First, the penalty will only apply to the amount you withdraw. And you can project what this amount will be. We’ll use an example from one CD, but you can do it for as many CDs as you need.
Let’s look at the rainy-day fund savings example from Part 1. Suppose you’ve saved enough to cover all six mortgage payments, or about $13,200 (six months of the national average mortgage payment of $2,200). It’s in a 12-month CD earning an annual percentage yield (APY) of 4 percent. And now, you only need to access $7,000. The early withdrawal penalty is 90 days’ worth of interest, and you have four months left to maturity.
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Lost interest to early withdrawal penalty
$7,000 x (0.04 /12) x 3 months’ worth of interest = $70
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Penalty not paid because of partial withdrawal
$6,200 x (0.04 / 12) x 3 months’ worth of interest = $62
Always check your financial institution’s rule for early withdrawal at origination. Some don’t allow it. Others have minimums for partial withdrawal that you’ll want to anticipate. Also, we’ve estimated penalties using months. Some banks’ penalties are in days and may result in minor rounding differences in the actual penalty assessed.
Second, maintaining a balance in your CD allows you to keep some of your savings invested at historically high rates, at least in terms of recent history. You save more by avoiding penalties and retaining as much principle as possible until the CD’s maturity.
Options available besides early withdrawal
Your savings is an asset to you, one that isn’t easy to accumulate. In an emergency, it can be more to your advantage to borrow against that asset than it is to spend it.
Commonly, when people think of borrowing small amounts, they think of personal loans or credit cards, which can have high interest rates because they’re unsecured. Did you know you can borrow against your CD at most institutions, and it’s considered secured debt? It’s called a CD-secured loan.
Banks can use CDs to repay a CD-secured loan if you don’t repay the loan. While interest rates vary by institution, the high security provided to lenders offering CD loans translates to much lower interest rates than a consumer loan and certainly lower than a credit card.
Which is better, a CD loan or a partial withdrawal?
Predicting which will benefit you more is impossible because loan rates vary. However, you can compare them once you know the rate of the CD loans available. Calculate partial or total withdrawal using the formula above in dollar terms, and then do the same for the loan’s interest. Often, the CD loan will be considerably more in your favor.
Withdrawing early
Sometimes, you must pull all your money out of your CD. While there may not be much you can do in that case, there’s one facet to watch: Accrued interest.
If, for example, your CD has a penalty of 90 days’ worth of interest, and it’s been more than 90 days since the CD started, you’re still owed any interest accrued. Most larger institutions today calculate accrued interest automatically and include it in your withdrawal amount. However, a fair number of smaller financial institutions still require you to walk into the branch with a physical certificate document for early withdrawal.
Double-check that you receive all interest accrued if a personal banker or teller calculates your withdrawal amount. Some people prefer to double-check these transactions regardless, even when done by software, just as they do for monthly bank statements compared to their checkbook and ATM receipts.
Bottom line
CDs bring many options to help you ensure every one of your dollars can become another, even though life throws you financial curve balls. Learning to manage those curve balls while still obtaining as much interest as possible is the best way to grow your savings safely.
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