A liquid certificate of deposit (CD), also called a "no-penalty CD," allows you to withdraw funds from the account before the term expires and pay no early withdrawal penalty for doing so. This allows you to take advantage of the higher interest rate a CD can offer over a regular savings account, yet maintain higher liquidity versus a traditional CD.
Learn what a liquid CD involves, how to use the account, its pros and cons, and what your alternatives are.
Definition and Examples of a Liquid CD
A liquid CD is a time deposit account that earns interest and, unlike other CDs, doesn't charge an early withdrawal penalty starting the seventh day after you open your account. Other types of CDs can have terms that extend for several years, but liquid CDs usually have short terms lasting just beyond one year at most. The financial institution pays you interest while you have the funds in the account, at a rate that’s often lower than that of a traditional CD with a similar term. Choosing a longer term such as 13 months versus seven months tends to lead to higher interest rates for a liquid CD.
- Alternate name: No-penalty CD
You can avoid having to give up interest earned or pay other fees like you would with a traditional CD as long as you follow the rules. But early withdrawals before day seven can lead to a penalty that may be based on the simple interest your CD would've accrued the first seven days.
Be aware that partial withdrawals could put you below your financial institution’s minimum balance to earn the advertised interest rate on the liquid CD.
Say that you have $5,000 to invest in an 11-month liquid CD that's paying an interest rate of 0.25%. The bank’s policies allow you to make a full withdrawal on day seven after account funding. You face a medical emergency two months after you open your liquid CD and need to redeem the CD early to pay your hospital bill. You log in to your online banking portal to request a full withdrawal of the principal and two months of interest. Fortunately, you don’t experience any penalty since the request occurred past the initial waiting period.
How a Liquid CD Works
Your bank or credit union may require a minimum deposit amount that can range from a few hundred to several thousands of dollars. You’ll usually have this transferred from another bank account, but you could also use a check. You can’t add more during the term after you invest this money in your liquid CD. This remains true even if you can make partial withdrawals later.
The financial institution usually pays a fixed interest rate on your liquid CD. The rate can depend on your location, deposit amount, term, market conditions, any special promotions, and the financial institution itself. You’ll want to compare several liquid CD offerings and select the right term and deposit amount to maximize your return. You’ll also want to consider whether you need a bank that allows partial withdrawals, and review any limits set on those (such as six per monthly cycle or once per term).
Credit unions tend to offer better interest rates as well as charge lower fees than banks.
The ability to withdraw funds seven days after opening your liquid CD makes this an appealing investment option if you’d rather not have your funds locked up in a traditional CD. Withdrawing funds early is often as simple as requesting the withdrawal through your online banking portal. However, some banks may require several days of notice prior to the withdrawal date.
You’ll be able to take action during the one- to two-week grace period that occurs upon maturity if you end up not withdrawing all the liquid CD’s funds early. Your bank will often automatically renew your CD for another term, but it might switch over to a traditional CD or change the term in some cases. Instead, you might opt to put the funds into another type of CD or add money to the CD if your needs have changed. Alternatively, you might just take your cash to use or to invest in something with a better return.
Let's say you never had to withdraw that $5,000 you invested in the 11-month liquid CD. You’ve therefore maximized your interest since you earned the 3% interest rate on the whole balance. Your bank now has a 10-day grace period and will automatically renew the liquid CD using the same term if you don’t act. You decide you want to have the liquid CD for another term but add another $5,000 to it.
You log in to your online banking, arrange to transfer the extra $5,000 from an external bank account, and agree to roll over the maturing CD funds. You then continue with a $10,000 11-month liquid CD at the currently available interest rate.
Pros and Cons of Liquid CDs
Flexible access to funds
Ability to avoid penalties
Lower return than traditional CDs
Temptation to remove funds
Withdrawal rules apply
- Guaranteed return: You have low financial risk when you go with a liquid CD because you’ll usually receive fixed interest on your investment. This type of savings account contrasts with other investments such as bonds, stocks, and mutual funds that can fluctuate widely and make you lose your investment.
- Flexible access to funds: Whether you need the money for an emergency or you see a better investment opportunity, having access to the liquid CD funds penalty-free after six days provides peace of mind. You get even more flexibility if you go with a financial institution permitting partial withdrawals.
- Ability to avoid penalties: Not having to pay an early withdrawal penalty eases the financial burden of needing your money prior to maturity. You don’t cut into your earnings as long as you follow the withdrawal rules.
- Safe funds: You can save as much as $250,000 in a liquid CD and not worry about losing your money. The Federal Deposit Insurance Corporation (FDIC) offers coverage for accounts through insured banks, while the National Credit Union Administration (NCUA) offers it for accounts through insured credit unions.
- Lower returns than traditional CDs: In exchange for the flexibility, liquid CDs tend to underperform compared to traditional CDs with similar terms. You might get only 0.10% interest on an eight-month liquid CD compared to 0.25% on a traditional six-month CD.
- Temptation to remove funds: Having easy access to your liquid CD could work against you achieving your goal if your goal is to maximize your earnings. You might opt to remove the money for a non-essential purpose and would miss out on the potential interest earned.
- Withdrawal rules apply: Having to wait until seven days have passed to access the money can be inconvenient if you face an unexpected financial emergency. You’ll usually face fees if your bank allows a withdrawal during that time. Accounts allowing partial withdrawals can limit the number you can make or require a minimum balance remaining, hurting the flexibility.
- Inflation risk: The low-yet-predictable return of a liquid CD comes with the disadvantage that your funds may not keep up with inflation. This especially can affect you in times when inflation is high and financial institutions are paying very low rates.
- Taxed earnings: The interest you’ve earned on your liquid CD will be taxable at your ordinary federal tax rate when you file your tax return. Therefore, you’ll want to consider your after-tax earnings on the funds.
Alternatives to a Liquid CD
A liquid CD can serve your needs if you want the flexibility and like the guaranteed return, but some alternatives can offer even easier withdrawals or higher interest rates. Some options to consider include traditional CDs, CD ladders, regular savings accounts, and money market accounts.
A traditional CD works a lot like a liquid CD except that it doesn’t offer the convenience of penalty-free withdrawals. You can expect an early withdrawal fee that cuts into any earnings if you remove your money prior to maturity.
On the other hand, this type of CD is available with a wide variety of short- to long-term options. You’ll usually earn a higher interest rate than with a liquid CD in exchange for less flexibility. Long-term traditional CDs can particularly offer appealing interest rates.
A CD ladder makes use of multiple CDs with varying terms so that you have access to some of the money as each of the CDs matures. This often means having five CDs where you split a specific amount of money evenly across them. You might take $5,000 and put $1,000 each in five CDs with terms of one, two, three, four, and five years.
Long-term CDs offer the potential for the highest interest rates but the lowest liquidity. Short-term CDs might offer lower rates, but they'll provide faster access to your funds because they mature sooner. You could pay the penalty if you need the money early. Otherwise, you can roll over the money from one CD to another to keep the ladder growing if you don’t end up needing the cash, and wait until maturity.
Regular Savings Account
A regular savings account that you open at a bank offers a lot of flexibility. You can add and remove money whenever you want. You also have several ways to withdraw money, such as visiting a branch, making online transfers, or withdrawing funds from an ATM. But your bank may charge you a fee if you make more than six withdrawals in a month, especially if they’re considered convenient withdrawals.
The Federal Reserve’s Regulation D used to limit money market and savings account withdrawals to six per monthly cycle prior to April 2020, so financial institutions would charge a fee for excessive withdrawals. This is no longer required, but some banks and credit unions may still impose withdrawal limits.
These accounts often have a low minimum deposit requirement that depends on the account package you choose. The bank may charge a monthly fee for maintenance unless you meet the criteria to waive it. These accounts also tend to earn lower interest rates compared to many types of CDs and money market accounts.
Money Market Account
A money market account offers a mix of savings and checking account features. It can offer a better return than a regular savings account and even some very short-term CDs. You can make withdrawals and deposits whenever you want, as you could with a regular savings account. However, you can also get a debit card and checks as you would with a checking account.
These accounts usually also require a minimum deposit to open, and your financial institution may charge a monthly maintenance fee that you could possibly get waived. Your financial institution might also charge you for money market account withdrawals beyond six per month.
- A liquid CD comes with the option to withdraw your money before maturity without an early withdrawal fee.
- This type of CD usually has a short term of under a year or just a few months, and comes with a lower interest rate than a traditional CD.
- You have to wait at least six days after opening the liquid CD to withdraw the money without penalty, and some financial institutions ban withdrawals in general during this period.
- Liquid CDs offer the benefits of a guaranteed return, insured funds, and high liquidity, but downsides include withdrawal rules, inflation risk, lower returns than traditional CDs, and taxes on earnings.
- Traditional CDs, CD ladders, money market accounts, and regular savings accounts are alternatives to liquid CDs.