Term of the Day: Early Withdrawal Penalty

After 10 consecutive interest rate increases aimed at fighting inflation, the Federal Open Market Committee (FOMC) is set to announce its latest rate decision this afternoon. The market consensus is that the Fed will likely hit the brakes on its rate-hiking cycle, with the CME FedWatch Tool showing a 93% probability that the federal funds rate will remain at its current level.

The likelihood of pause a by the Fed could be taken as a reminder that the high interest rates paid by the top high-yield savings accounts won't be around forever. One way to lock in a higher annual percentage yield (APY) is through a certificate of deposit (CD), with the best CD rates at or above 5%. However, the tradeoff of a CD is that you commit to leaving your funds in the account until end of the term—if you access the money before then, you will be on the hook for an early withdrawal penalty.

CDs can be an attractive place to stash your money when interest rates are declining, since they could allow you to secure a higher yield on your deposit until the CD reaches maturity. The APY on a traditional savings account typically declines in line with the prevailing market interest rates, but a CD continues paying a fixed rate for its entire term.

In exchange for these more stable returns over an extended time frame, you give up some capacity to access your funds. If you take money out of your CD before the end of the agreed term, you will be subject to an early withdrawal penalty.

The amount of the penalty may vary depending on your financial institution. According to federal regulations, banks must charge a fee for early withdrawals from time accounts such as CDs that is equal to at least seven days worth of interest payments. Since there is no specified maximum, the actual early withdrawal penalty could be significantly higher.

With the prospect of interest rates stopping their march higher and beginning to abate, a CD could be a good option for guaranteeing strong returns on your savings for some time into the future. But if you're considering this strategy, you should be confident that you can leave the funds in your CD until it reaches maturity.

Even if you plan to keep your money deposited for the entire term, it's a good idea to check the early withdrawal penalties associated with any CD you're considering. This way, if you do need to tap into the account due to unforeseen circumstances, you'll know what penalties to expect.