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Watch Out for Penalties for Cashing a CD Out Early

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The biggest risks with certificates of deposit is inflation and interest rate risk. Inflation risk is the risk that the interest you earn won't overcome the loss in purchasing power because of rising inflation. Interest rate risk is the risk that interest rates rise while you're locked into a CD. While both risks are real, they're often overlooked because CDs don't suffer from principal risk, the risk that your original investment could lose actual value. One mitigating factor with CDs is that you can always close them early.

The standard early withdrawal penalty on a certificate of deposit is three months of interest if the CD has a maturity period of less than a year. The penalty increases to six months of interest if the CD has a maturity period of a year or more. Ally Bank, however, has a much lower penalty - a mere sixty days.

Calculating the Penalty

Most banks use the standard three month and six month penalties because they work to deter people from closing CDs early. It's a planning tool. By lowering the penalty to only sixty days, it tempts math savvy savers to see whether it may make sense for them to open a long term CD with the option of closing it should interest rates go up.

This point was not lost at MyMoneyBlog where Jonathan took a closer look and discovered that Ally's 5 year CD simply cannot be beat if you can hold it for more than four months. If you close it after four months, you would've received effectively a 1.52% APY, trumping even the best savings account rates. At 1 year, the annualized rate increases to 2.57% APY, much higher than 1-year CD rates. After 2 years, you're looking at 2.84% APY and after three it's 2.91%. At every benchmark of best CD rates, this 5 year CD with a 60 day interest penalty is tops at the moment.

So if you're looking for a CD and you have an account at Ally Bank, skip their no penalty CDs because their penalty of only 60 days makes their 60 month CDs very very attractive.

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