Liquid CDs

Pros and Cons of Flexible CD Accounts

Locked up Money
Don't like the idea of locking up your money? You've got options. REB Images/Blend Images/Getty Images

Certificates of deposit (CDs) are great tools for earning more on your cash. But what if you need your money back before your CD matures? What if interest rates rise right after you buy a CD – are you stuck with that low rate for the entire term, or can you move your money to a higher-paying CD?

Liquid CDs address the problems above, but like everything they have their pros and cons.

What is a Liquid CD?

A liquid CD is a CD that allows you to take your money out before the CD matures without paying early withdrawal penalties.

They are sometimes known as “risk free” or “breakable” CDs, depending on where you bank.

With standard CDs, your bank will charge fees if you pull your funds early. Sometimes you’ll even pay more than you’ve earned in interest – so you’ll end up with less than you started with (they’ll pull from the original principal investment). For example, if you buy a 12 month CD, you might have to pay six months’ worth of interest to withdraw before the maturity date. If you’ve only had the CD for three months, that six month penalty will cost more than you’ve earned.

Liquid CDs are different. Assuming you follow all of the bank’s rules (see below), you can make early withdrawals penalty-free. That’s good news if you need the money early.

Tradeoffs

There is no such thing as a free lunch, so what’s the cost of using a liquid CD? In general, these CDs pay less interest than standard CDs – and that makes sense because you have the freedom to pull your funds out.

You’ll earn less on your savings with a liquid CD, but your risk is lower. That makes it easier to commit to a CD when interest rates are low (but expected to rise at an unknown date in the future). You can also live with a skinnier emergency fund in savings if you know you’ve got backup funds available in liquid CDs.

Is the lower rate worth it? It depends on your situation, of course. There are other alternatives.

How they Work

Getting money from a liquid CD isn’t as simple as calling the bank anytime you feel like it (but it’s not far off). Every bank and credit union is different, so you’ll need to review the policy at your financial institution before you buy a CD.

How much: some banks allow you to pull 100% of your account balance from liquid CDs, while others require you to keep a certain percentage of your initial deposit in the account. Some simply require you to keep a minimum dollar amount in the account to avoid penalties.

Timing matters: at most banks, you need to wait for at least a week after opening your liquid CD to pull the funds out – so don’t invest cash that you’ll need right away. After that, some banks allow penalty-free withdrawals monthly or weekly, while others allow only one penalty-free withdrawal during your CD’s term.

Pay a penalty: if you can’t meet the criteria for penalty-free withdrawals from your liquid CD, you might still have the option to “break” your CD and pay penalties. That would be unfortunate, since you’d earn less interest and have to pay fees, but it might be necessary in an emergency.

Alternatives to Liquid CDs

Before you use a liquid CD, evaluate all of the options. Find a creative solution that fits your life and your money personality. A few examples are below.

Solid emergency fund: keep an emergency fund that’s adequate to cover most of life’s curveballs, and put the rest of your “safe money” in standard CDs. If it turns out that you need more than you’ve got in the emergency fund, go ahead and break a CD (and pay penalties). This isn’t something you’re planning to do, and it shouldn’t happen often enough to break the bank.

CD ladders: a laddering strategy ensures that you’ve always got a CD coming up for maturity in the near future (within three to six months). If you won’t need money immediately, those regular maturities can help you get through tight spots. Plus, if interest rates rise, you’ll continually reinvest at higher rates.

Money market accounts: if you really don’t want to lock your money up, look into money market accounts as an alternative to liquid CDs. They pay almost as much as CDs, but you have the ability to write a few checks and move the money around (although money market accounts also have limitations – check with your bank).