CD Penalty Manipulation: Is it Investment Efficient to Accept Withdrawal Penalties and Reinvest?

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Is it investment efficient to accept CD penalties for early withdrawal, to reinvest if rates rise?

The concept of a Certificate of Deposit (CD) is neither unique nor special to banking institutions, however they do pose as a vehicle for a few interesting methods of \"bank investing.\" A CD is a 'time deposit' account at a banking institution (traditional, credit union or internet based) in which the investor guarantees the banks exclusive usage of the funds for a specific amount of time in turn for interest. This interest is usually compounded on a daily basis but credited monthly. Because of this time commitment contract, this rate is usually higher then savings or money market deposit accounts. Interestingly, in times of financial strife, banks may increase the interest rates as an enticement to secure guaranteed assets for their own treasury.

These types of investments are considered in the FDIC insurance of $250,000 per individual per class of ownership. Liquidity becomes the greatest issue with these types of risk-less investments. Because of this 'guarantee' to the bank, early withdrawal will result in penalties. These penalties vary in size - usually being equivalent to three (3) months worth of average accrued interest for CDs with a 12 month or less maturity or six (6) months for those greater than one year. If the withdrawal occurs before enough interest has accrued, the bank may invade the principle.

With these penalties, one may wonder that since the banks frequently change interest rates (in response to the Federal Reserve changing interest rates), could it be investment savvy to accept a penalty in order to reinvest the funds at a higher rate in another CD?

For this to be a consideration, we must make certain assumptions.

  • Interest is credited at the conclusion of the day.
  • Interest is compounded daily (a norm for most CDs).
  • This is a traditional CD, not one in which the rate may be adjusted or funds may be withdrawn upon without penalty.
  • Penalties will follow the aforementioned guidelines (average of three months interest for 12 month or less maturity and average six months of interest for greater than 12 month maturity).
  • We will assume a 30 day month (360 day year).
  • No interest payment will be made in the form of coupons and all interest will be reinvested.


Here are examples of a 1 year and a 5 year CD at average current rates (found at Note that since the bank has a guarantee of your money for a longer duration of time the 5 year rate is much higher than the 1 year.

Initial investment in both: $10,000

CD A - 12 month rate: 1.65 APY (0.0000452 daily rate)

CD B - 60 month rate: 3.15 APY (0.0000862 daily rate)

Total interest for CD A would be ~$164.00 with a monthly average of ~$13.70. (3 month $41.10).

Total interest for CD B would be ~$1679.20 with a monthly average of ~$28.00. (6 month $168.00).

With these figures it must be noted that the penalties are usually an average interest and since this is compounded daily, interest accrued in month one is less than month 2, etc. So, one would lose principle if CD A was redeemed before or at the 3 month mark or CD B before or at the 6 month mark.

Technically it would be possible to absorb the penalty if the APY increased; it would have to increase by over 230 basis points to make up the three month penalty on the 12 month CD at 1.65% in the first month. The APY would have to increase by over 500 basis points on the 5 year CD.

Given that we are in uncharted territory with the Federal interest rate floating between 0% to 0.25%, chances are slim that the interest rates will spike so quickly. If they were to do so, getting back you CD penalty would be the least of your worries. See: Zimbabwe 100 Trillion Dollar Bill. We are not prepared for such inflation/hyper inflation. The best way to leverage the change in CD rates would be to ladder your investments.

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Today's Highest Online CD Rates

Bank Product Term Interest Rate (APY)
M.Y. Safra Bank 1-Year 2.51% APY with $500 minimum
Sallie Mae Bank 1-Year 2.50% APY with $2,500 minimum
Discover Bank 1-Year 2.30% APY with $2,500 minimum
Pentagon 3-Year 3.25% APY with $1,000 minimum
Popular Direct 3-Year 3.10% APY with $10,000 minimum
M.Y. Safra Bank 3-Year 3.06% APY with $500 minimum
Bread Savings, a division of Comenity Capital Bank 5-Year 3.65% APY with $1,500 minimum
M.Y. Safra Bank 5-Year 3.26% APY with $500 minimum
Popular Direct 5-Year 3.25% APY with $10,000 minimum

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