What Is a No-Penalty Certificate of Deposit (CD) ?

What Is a No-Penalty Certificate of Deposit (CD) ?
••• anyaberkut/iStock/GettyImages

When you want to save money, various types of certificates of deposit can meet your needs if you'd like to avoid more risky investments and see a stable return. While most CDs charge a penalty for withdrawals made before the term ends, a no-penalty CD or liquid CD offers more flexibility in that you can remove your funds early without losing money for doing so. However, you should be aware of both the benefits and trade-offs that come with this kind of account. Learn all about how a no-penalty CD works to decide if it fits your investment needs.

Understanding No-Penalty Certificates of Deposit

When looking at a no-penalty CD, you'll find that it has a lot in common with alternatives like traditional and jumbo CDs. Banks offering these accounts will pay a fixed annual percentage yield on the amount you deposit in your CD, and this rate can vary by the location, the amount deposited and the financial instituti0n. Often, you'll find that you need to deposit a minimum amount of money – often anywhere from $250 to $1,000. However, a difference is the term length for no-penalty CDs tends to run several months to just over a year, versus other CDs that can have terms lasting several years.

You'll find that these accounts mostly work differently after you open them. Most other types of CDs are made to hold the money for the set term, and any withdrawal leads to penalties involving interest earned or other fees charging a percentage or flat rate of the balance. However, a no-penalty CD only has a short period at the beginning of the account opening, usually six days, during which you can't make withdrawals. So, once that time ends and you see a better rate elsewhere or just need the money, you can pull your whole principal and interest earned without penalty.

If you decide to keep your no-penalty CD to maturity rather than withdraw the funds and close it early, your bank usually provides multiple options for how you handle the account and funds. You could simply cash out and close the account to use the money or invest elsewhere. You could also renew the CD for another term and potentially get a relationship bonus rate for doing so. The bank may also let you make changes like add to the CD or choose another term length at maturity.

Exploring No-Penalty CD Benefits

When you invest your money in a no-penalty CD, you get the numerous benefits that come with CDs in general along with special perks for this type of account. These benefits include the following:

  • Flexible account access: The main appeal of the no-penalty CD is the ability to take out money early without penalty, as long as you've waited through your initial hold period according to the bank's terms. This can give you more peace of mind since you can easily get your money out if a need arises, and it makes this CD type suitable for short-term savings goals. It also means less risk if interest rates rise since you could just take the money out early and open a new CD with the higher interest rate available at the time
  • No early withdrawal penalty: With most CDs, an early withdrawal will come with a penalty that widely varies. For example, you may lose a number of months of earned interest, or pay fees based on the amount you withdraw. A no-penalty CD helps you keep your principal plus interest accrued so that you can better meet your savings goals rather than get further behind.
  • Better interest rate: When looking at standard savings accounts that can pay as little as 0.01 percent in interest, any kind of CD usually nets a better return. The higher interest rate results from the bank's expectation that you'll hold your money in the CD until maturity. For the best return on a no-penalty CD, you can compare rates at several financial institutions including brick-and-mortar and online banks and choose the highest-earning option.
  • Predictable earnings: When you put money in the stock market, you can face sharp swings where you gain and lose money. Of course, you can get a high return in the long run, but your investment preferences may involve something more stable and predictable for short-term savings. A no-penalty CD guarantees one set rate, and you don't have to worry about losing any of the money in the account or having the interest rate cut.
  • Protection for your money: Along with benefiting from stable earnings, you get federal protection for the money in your CD when you choose a bank that bears Federal Deposit Insurance Corporation insurance. You don't have to worry about losing the money in your CD if the insured bank fails as long as the balance doesn't exceed $250,000 for an account with a single owner.
  • Variety of account options: Whether you have just a small amount to invest or want to put away $10,000, you can find many no-penalty CD options with different terms, minimum deposit requirements and interest rates. You can also find banks with perks like a relationship bonus when you renew the CD.

Considering No-Penalty CD Drawbacks

While no-penalty CD accounts come with little risk, you should understand some drawbacks when choosing this type of account for your savings. Some downsides include the following:

  • Harder to find: While you could probably find a traditional CD easily at a current bank where you already hold a credit card or regular savings account, you'll find that no-penalty CDs take more work to find. So, you may need to do more research to find a local bank with this option or consider online banks that offer a wider selection of financial products.
  • Less competitive interest rate: When looking at the APY for a no-penalty CD and comparing it to the rate that traditional and jumbo CDs get, you'll likely notice a slightly lower return due to the flexibility provided. At the same time, you'll find that you could get a much better return with stocks and bonds, especially for long-term savings.
  • Rules on withdrawals: Despite the flexibility you get with a no-penalty CD when it comes to withdrawing funds, banks still have policies that you need to follow. First, this means waiting until the initial waiting period ends before initiating a withdrawal. Second, CDs usually do not allow a partial withdrawal during the CD term, and this can take away from the flexibility.
  • Inability to add funds: Unlike an add-on CD, a no-penalty CD usually allows for just a one-time deposit when you create your account, and you'd have to wait for maturity to make any additions. Otherwise, you'd need to go through the process of opening a new CD to further invest funds. This not only can be inconvenient but can also potentially hurt you financially when interest rates decrease, as you'd have to accept whatever rate the bank offers at that time.
  • No increase in rates: Like other types of CDs that offer a fixed interest rate, you get the disadvantage of not seeing that rate rise even if market conditions improve. While a no-penalty CD would allow you to take the money out early and invest it elsewhere, you have to go through the hassle of doing so. At the same time, the lack of rate increase means that inflation can rise to the point where your CD rate just can't keep up for a good return.
  • Tax on interest income: No matter how little interest you earn on a CD or other savings account, the Internal Revenue Service considers it income, and that usually means extra income tax due. The IRS will use your regular income tax rate when determining what you owe.

Finding No-Penalty CD Options

If you're seeking a no-penalty CD, you can begin searching online and traditional banks along with credit unions. You can also take a look at a few options available as of September 2020:

  • Ally: This online bank offers a competitive 0.75 percent APY on its 11-month no-penalty CD and doesn't have a minimum deposit. If you renew at maturity, you get a loyalty bonus of 0.05 percent.
  • Marcus: This division of Goldman Sachs offers a no-penalty CD with a term of seven months and APY of 0.75 percent. You need to deposit at least $500 to open the account.
  • CIT Bank: You can open an 11-month no-penalty CD at this brick-and-mortar bank with a $1,000 minimum deposit and earn a 0.35 percent APY.
  • Simple: The 12-month no-penalty CD at this online bank has a 0.70 percent APY and $250 minimum deposit. This bank has a withdrawal waiting period of a full week and requires that you have an existing checking account with them before opening a CD account.

Comparing to Other CD Types

Along with considering no-penalty CDs, you have other CD options with their own pros and cons. Here are just a handful of other CD products for comparison:

  • Traditional CD: This type offers longer-term options and slightly higher interest rates than no-penalty CDs, but withdrawals come at a penalty.
  • Bump-up CD: Unlike a no-penalty CD, you can bump your rate up once if market rates rise during the term, but you can't withdraw free of penalty.
  • Jumbo CD: This CD variety can offer a better interest rate since you're required to hold a large balance, sometimes as high as $100,000. This could mean a steeper penalty for early withdrawals and less accessibility for those without significant money.
  • Brokered CD: While you'll get your no-penalty CD through a credit union or bank, you'd turn to a brokerage for this kind of CD, and they'd handle finding CD products at various banks. While this can mean better terms like higher interest and a wider variety, FDIC coverage works differently so you have to be sure to choose a brokerage in good financial standing.
  • Step-up/step-down CD: Compared to fixed-rate no-penalty CDs, this variety pays different interest rates in steps either upward or downward. Depending on the term, you could experience several steps before maturity.
  • IRA CD: Used for long-term retirement savings, you get tax advantages like you get with standard IRA accounts and can put away up to the maximum contribution limit for IRAs in CD accounts each year. However, it usually offers much lower returns than IRAs composed of products like stocks, mutual funds and bonds.

Moving Forward With Investing

If you like the liquidity a no-penalty CD offers and understand the pros and cons versus other types of CDs, consider doing research to compare terms and find the right financial institution with FDIC coverage. You can usually fill out your no-penalty CD application online and move money from a checking or savings account to make your deposit. Otherwise, you can visit a local branch to apply and fund the account with a bank transfer, cash or check if you prefer. You can then sign up for online banking to track your CD earnings and manage the account.