A certificate of deposit (CD) is a type of savings account in which the issuing financial institution pays interest on a fixed amount of money for initial deposit for a fixed period of time. The terms can range anywhere from one month to five years, and even up to 10 years in some cases.
While CDs can earn you interest on the money you deposit, they can also come with costs that may chip away at your earnings. Here’s a closer look at the different CD costs you may encounter, and how to minimize or avoid them.
- Brokered CDs may come with broker fees. They are usually the highest for broker-assisted purchases in the secondary CD market.
- Withdrawing your CD deposit before it matures can result in early withdrawal fees that reduce your interest earnings.
- The interest income earned from CDs is taxable in the year it becomes available to you.
While you can buy traditional certificates of deposit directly from banks and credit unions, brokered CDs are bought by third-party brokers who then sell them to you. When sold for the first time, they are called “new issues” in the primary market. If you buy new issues, you usually won’t incur a fee since you’re buying the brokered CD from the issuer through the broker. For these, a broker typically receives a placement fee from the issuer.
However, when owners of brokered CDs want to cash them out before their maturity dates, they can sell them in what’s known as the secondary market. If you buy one of these, your money will go to the current CD owner instead of the original issuer, and you’re more likely to run into broker fees.
How Much Do CD Broker Fees Cost?
Fees can vary from one broker to the next, so it's best to inquire ahead of purchasing a CD to find out if and how much of a fee you'll incur.
Vanguard Brokerage Services, for example, doesn’t charge a fee on new issues, but does charge $1 per $1,000 of the CD face amount (up to $250) for brokered CDs bought in the secondary market. You’ll also be charged a $25 broker-assisted fee for CDs you trade in the secondary market by phone. So if you bought a $250,000 brokered CD from the secondary market over the phone with a Vanguard broker, you could end up paying $275 in fees.
How To Minimize CD Broker Fees
To minimize CD broker fees, look for brokerages that don’t charge fees or that charge fees lower than others. Like Vanguard, Merrill charges a fee for broker-assisted trades in the secondary market. However, Merrill’s fee is $29.95 per trade. By opting for Vanguard, you could save $4.95 per trade.
When you buy brokered CDs that are new issues, you’ll typically see fewer fees, if any, which can help you save. On the other hand, if you decide to buy a brokered CD in the secondary market, you can often minimize your fees by conducting the trade online without the phone assistance of a broker.
Early Withdrawal Fees
Early withdrawal fees, commonly known as early withdrawal penalties, are fees you have to pay if you withdraw money from a CD before it matures. For example, if you invested $1,000 into a CD for one year but needed the money after six months, you’d likely face a penalty for the early withdrawal.
How Much Do CD Early Withdrawal Fees Cost?
These fees vary from one CD issuer to the next, and can also vary between CD products from the same issuer. The longer the CD term, the larger penalty you will likely face. In many cases, the penalties are structured as a number of months or days of interest that you lose.
Here’s a sample of penalty amounts:
|Term||Early Withdrawal Penalty|
|12 months or less||90 days of simple interest at the current rate|
|More than 12 months but less than 48 months||180 days of simple interest at the current rate|
|48 months or more||365 days of simple interest at the current rate|
In this case, if you put your money into a one-year CD but withdrew it before the maturity date, you’ll have to pay the equivalent of 90 days of interest.
How To Avoid CD Early Withdrawal Fees
There are a few ways you can avoid or minimize early withdrawal fees.
- Don’t overcommit: The first way to avoid an early withdrawal penalty is to choose a CD term you know you can see through to the maturity date. If you have any doubts about a term length, opt for a shorter one.
- Explore liquid CDs: A liquid CD is a type of CD without early withdrawal penalties. This may be a good choice if you think you may need to cash out early. However, it typically comes with a lower APY.
- Use CD ladders: CD laddering is a strategy that staggers CD investments so they mature at regular intervals. This can help you to avoid early withdrawals while maximizing your annual percentage yield (APY).
- Shop around: Some banks will have higher penalties than others. When choosing a CD, you can minimize penalties by shopping around and choosing a CD with lower fees.
Taxes on CD Interest
The third cost you will face with a CD is the tax you’ll owe on the interest you earn. Interest income from CDs is considered taxable income in the year it becomes available to you. If a CD spans more than one tax year, you’ll report the interest earned at the end of each year, even if you haven’t withdrawn it yet.
You won’t pay tax on the full CD amount, just on the amount of interest you earn from the CD each year.
How Much Do CD Taxes Cost?
Interest income is added to your other income and taxed at the ordinary income tax rates. The amount you have to pay will depend on your tax bracket. For example, say you are filing as the head of household who earned $50,000 from your wages and $100 in interest income from your CDs in 2021. The first $14,200 you earned would be taxed at the 10% rate and the rest would be taxed at the 12% rate.
How To Minimize CD Taxes
There’s not much you can do about taxes on your interest income. The more you earn, the more you’ll pay. However, you can deduct any penalties you are charged by your CD issuer.
Frequently Asked Questions (FAQs)
Are CD early withdrawal penalties tax deductible?
Yes, early withdrawal penalties are tax-deductible. If you are charged an early withdrawal penalty, you’ll receive a 1099-INT or similar statement that lists both the interest you earned and the amount of your interest penalties. You’ll be able to deduct the penalty amount by entering it on line 18 of your Schedule 1 (Form 1040).
When a CD term ends, do I have to pay a fee to transfer the funds?
When a CD matures, you should not have to pay a fee or any penalties to transfer your funds. However, be sure to check with the financial institution issuing your CD before signing up, to prevent any surprise fees.
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Raymond James. “Investing in Brokered Certificates of Deposit.”
Vanguard. “Brokerage Services Commission and Fee Schedules.”
Merrill. “Self-Directed Trading Fees and Commissions.”
Synchrony. “Certificate of Deposit.”
IRS. “Topic No. 403 Interest Received.”
IRS. “26 CFR 601.602: Tax Forms and Instructions,” Page 6.