No-Penalty CD: What It Is and How It Works

If you're looking to save money and take advantage of interest rates higher than you'd get with a traditional savings account, a certificate of deposit (CD) might be a good option to help you reach your financial goals. Not only do CDs offer competitive interest rates, but they're also among the safest investments you can make. Your return is fixed and guaranteed.

One major drawback to traditional CDs, however, is the early withdrawal penalty, which reduces some of the interest you gained if you take out your funds before the end of your CD term.

But there's a solution. If you haven't opened a CD in the past because of the early withdrawal penalty, a no-penalty CD might be worth considering. No-penalty CDs offer all the benefits of a traditional CD without the penalty of early withdrawals, allowing you to withdraw funds before your maturity date without losing your earnings.

What Are No-Penalty CDs?

A no-penalty CD is a type of certificate of deposit account that allows you to withdraw your funds before the maturity date (the last date of the CD's term) without your losing any of the interest gained while your funds were in the account.

No-penalty CDs are typically Federal Deposit Insurance Corporation (FDIC) insured—so if an FDIC-member bank fails, you can get your money back, up to an eligible amount. You can also decide how much you want to deposit into a no-penalty CD (within the bank's minimum deposit guidelines) and select the maturity date that works best for your goals.

The no-penalty CD interest rate is guaranteed for the length of its term, which can be very helpful if market rates begin to fall.

How Do No-penalty CD Accounts Work?

In many ways, a no-penalty CD operates just like a traditional CD. With both savings vehicles, you lock in an interest rate for a certain amount of time. In general, the longer the term, the higher the rate. But there's a key difference: There's no penalty for an early withdrawal from a no-penalty CD account, giving you the ultimate flexibility to access all your funds.

With a traditional CD, you agree to lock in your funds for a term (usually three months to five years) in exchange for a competitive fixed interest rate. If you break the CD contract early, you'll lose a portion of the interest you gained and possibly some principal, depending on how soon you break the CD.

The no-penalty CD eliminates the early withdrawal penalty entirely, letting you withdraw funds as soon as six days after opening your account. Six days is the federal guideline; your bank might require you to wait longer.¹

With a no-penalty CD, whenever you're authorized to withdraw, you can do so and keep any interest you've earned.

As with a traditional CD, your no-penalty CD will have a term, or set period in which you'll earn interest. The term ends on the CD's maturity date. At that time, you'll receive the full amount of interest earned on your principal (the amount of money you originally invested) on top of your principal investment.

Benefits of No-penalty CDs

• Interest earnings. CDs generally offer higher interest rates than other savings vehicles, giving you more money during the period you have your funds in the account.
• Flexibility. You won't lose the interest earned if you withdraw your funds before your no-penalty CD's maturity date. You can simply withdraw your principal and interest earned, and close the account.
• Security. Like all savings accounts, no-penalty CDs are typically insured by the FDIC, so you won't lose your principal or interest earned if a member bank fails.

Downsides of No-penalty CDs

• You likely have to close the account if you want to take money out. If you withdraw funds early, many institutions will require you to withdraw the full amount and close the account. While you'll receive all the interest you earned up to that point, you can't make partial withdrawals and keep the account open to continue gaining interest.
• The interest rate may be less competitive. The trade-off for the flexibility of a no-penalty CD is a lower yield. While still competitive, interest rates on no-penalty CDs are generally lower than those of traditional CDs.

Comparison of No-penalty CDs With Other Accounts

Is a no-penalty CD right for you? Know the differences between no-penalty CDs and other types of savings accounts to make the best choice for your financial needs and goals.

No-penalty CD vs. Traditional CD vs. Bump-up CD

All three CD accounts have similar benefits—higher yields, fixed terms and FDIC insurance (if your bank is a member), meaning you won't lose your money. But there are some differences.

No-penalty CDs allow you to withdraw your principal and interest earned before the CD term ends without your losing any of your earnings. With a traditional CD, you will lose some of your interest earned if you withdraw funds before your CD's maturity date.

Interest rates for traditional CDs are usually higher than rates for no-penalty CDs, so if you're confident you won't withdraw your money before the maturity date, a traditional CD might be a better option to earn more.

Bump-up CDs offer a blend of the other two savings products. Unlike no-penalty CDs and traditional CDs, which have a fixed interest rate for the entire CD term, bump-up CDs offer the opportunity to request a one-time annual percentage yield (APY) and interest rate increase during your term. If rates offered for the bump-up CD rise, you can take advantage of the higher rate—an option you wouldn't have with a traditional or no-penalty CD. Bump-up CDs do have early withdrawal penalties and generally offer lower initial interest rates than traditional CDs, but bump-up CD rates still tend to be higher than no-penalty CD rates.

No-penalty CD vs. Checking Account vs. Savings Account

Compared to all CDs, you'll get more overall flexibility from savings and checking accounts, which allow partial or full withdrawals at any time with no penalty. If you want to remove funds from a traditional savings or checking account, you won't have to make a full withdrawal and close the account like you would with a no-penalty CD.

In addition, traditional checking and savings account interest rates aren't fixed; they can rise and fall with market rates, and your earnings can fluctuate over time.

Most savings and checking accounts will have lower interest rates than those of no-penalty CDs.

If flexibility is important or you know you can't lock away your money for a set period of time, traditional savings and checking accounts might be your best option. You'll just give up the benefit of higher interest in the process.

How to Choose Between No-penalty CDs vs. Other Accounts

As with any savings tool, the best choice depends on your specific needs and goals.

Some savers might consider early withdrawal if interest rates for savings accounts begin rising across the board and they want to invest in a new account with a higher yield. While this can be a valid choice, savers who like to follow the market closely but want the security of a CD account might consider a bump-up CD, which lets you request a one-time APY and interest rate increase during the CD's term.

This table can help clarify the differences so you can make an informed choice.

How to Open a No-penalty CD Account

You can open a no-penalty CD account at any bank, credit union or financial institution that offers it. Each bank has its own process to open a no-penalty CD account.

The Bottom Line

A no-penalty CD could be one of the options to consider as a savings vehicle if you're looking for a risk-free investment offering a competitive interest rate and the flexibility to withdraw early without penalty, if necessary.
 

LEARN MORE: How to Choose Your CD Account in an Uncertain Economy