Benjamin Franklin said "A penny saved is a penny earned." The pennies you save can grow as they earn interest over time, but there are circumstances where making withdrawals from your savings can cost you money. Before you deposit hard-earned cash into an account, it's important to understand any restrictions on withdrawing that cash.
Certificate of Deposit
A certificate of deposit is an investment you make with a bank or other financial institution. You deposit a specific amount of money in the bank and agree to leave it there for a predetermined length of time. You earn a higher interest rate than you would have if you'd put the same amount of money in a savings account that lets you take out money at any time without a penalty. When time runs out, you can withdraw the amount you invested plus the interest your money earned.
Early Withdrawal Penalties for CDs
You incur a penalty for making early withdrawals from a certificate of deposit because withdrawing money before the term of the CD runs out violates your CD agreement with the bank. The details depend on your CD agreement, but generally speaking, the bank assesses a penalty of 60 days or more worth of interest on the CD. If the amount of the penalty is more than the amount of interest accrued on your original investment, the bank deducts the difference from your CD.
Individual Retirement Accounts
Funds you hold in a traditional individual retirement account are generally subject to penalties for withdrawals you make before you reach age 59 1/2. Your deposits in an IRA, up to a limit, are not included in your taxable income in the year you earn them. Instead, income taxes are deferred on your IRA contributions and accrued earnings on those contributions. Taxes are assessed when you withdraw money from your IRA. If you deposit money in a Roth IRA, your contributions are taxable in the year you earn them, but taxes are not assessed on the earnings your contributions accumulate.
Early Withdrawal Penalties for IRAs
Penalties apply to withdrawals you make from a traditional individual retirement account before you reach age 59 1/2. You'll have to pay any federal and state income tax on your withdrawals, along with a 10 percent early withdrawal penalty. With a Roth IRA, you'll pay taxes and penalties on the earnings you withdraw but not on your contributions -- you already paid income tax on contributions. In both instances, the taxes and 10 percent penalty are due when you file your income tax return for the year you made the early withdrawal.
- The Wall Street Journal: What Is a Certificate of Deposit (CD)?
- Ally.com: Ally Bank and CD Fees
- Internal Revenue Service: Publication 590
- Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions." Accessed Mar. 20, 2020.
- Internal Revenue Service. "Topic No. 557 Additional Tax on Early Distributions from Traditional and Roth IRAs." Accessed June 19, 2020.
- Internal Revenue Service. "Traditional and Roth IRAs." Accessed June 19, 2020.
- Internal Revenue Service. "Traditional IRAs." Accessed Mar. 20, 2020.
- Internal Revenue Service. "Topic No. 451 Individual Retirement Arrangements (IRAs)." Accessed June 19, 2020.
- Internal Revenue Service. "Roth IRAs." Accessed Mar. 20, 2020.
- Internal Revenue Service. "Publication 590-B (2019), Distributions from Individual Retirement Arrangements (IRAs)." Accessed Mar. 20, 2020.
- Internal Revenue Service. "Designated Roth Accounts - Distributions." Accessed Mar. 20, 2020.
- Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions." Accessed June 19, 2020.
Marilyn Lindblad practices law on the west coast of the United States. She has been a freelance writer since 2007. Her work has appeared on various websites. Lindblad received her Juris Doctor from Lewis and Clark Law School.