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- No-penalty CDs have a fixed interest rate for a term and don't have early withdrawal fees.
- With a savings account, the interest rate may fluctuate, but you can deposit money more than once.
- Unless you find a high interest rate on a no-penalty CD, you'll likely prefer a savings account.
No-penalty CDs and savings accounts are two types of interest-earning bank accounts. But which is the better option for you?
We'll explain the similarities and differences between the two types of accounts and help you figure out which meets your needs.
Understanding no-penalty CDs and how they work
What is a no-penalty CD?
A certificate of deposit, or CD, is an FDIC-insured bank account that earns a fixed interest rate for a specific length of time. Usually you will pay a fee if you withdraw money from a CD before the end of the term.
A no-penalty CD is a special type of account that doesn't charge early withdrawal fees and still earns a fixed rate of return. No-penalty CDs are sometimes called flexible CDs.
How no-penalty CDs work
If you need to withdraw money before your no-penalty CD matures, the bank won't charge you a fee. Some banks may still list limitations in the terms and conditions agreement, however. For example, you might not be able to withdraw money from a CD during the first five days of opening an account, or you might not be able to make any partial withdrawals.
The main benefit to a no-penalty CD is that your rate will stay the same until the CD matures. If you open an account with a competitive interest rate, you'll be able to lock in that rate for the entire term.
Other savings account rates will fluctuate depending on whether the Federal Reserve raises or lowers interest rates. You may be happy you have a no-penalty CD when Federal Reserve rates drop, because you get to keep your higher rate. However, when the Federal Reserve raises interest rates, you could potentially lose out on higher savings rates if your money is in a CD.
When should you choose a no-penalty CD?
Alvin Carlos, a CFP professional and managing partner of District Capital Management, points out that the interest rate a CD earns could play an important factor when deciding whether you should get a no-penalty CD.
"You should only choose a no-penalty CD if the rate is significantly higher than a high-yield savings account," says Carlos.
If you decide to open a no-penalty CD, you'll also want to pay attention to the CD maturity date. Carlos says that he generally recommends not automatically renewing a CD in case you may need some of those funds. Once the term ends, you can look at the bank's new rates to decide if you want to put the money into a CD again.
Carlos also says you may want to keep an eye on the rate before your CD term ends. If the bank significantly increases the CD rate, you can withdraw money (without paying a penalty), then redeposit it into a new CD at the higher rate.
The process for cashing out a CD varies between financial institutions. If you are banking with an online bank, you could call customer support or make changes through your online account or the app. But if you opened a no-penalty CD at a local bank, you might need to fill out paperwork.
Understanding savings accounts and how they work
What is a savings account?
A savings account is a type of bank account that earns interest on the balance and compounds either daily or monthly. Unlike a checking account, there may be limitations to how often you can make withdrawals or transfers from a savings account, and you will typically not be provided with a debit card to make purchases directly from the account.
How savings accounts work
The rate on a regular savings account fluctuates because it's influenced by what the Federal Reserve does. If the Federal Reserve raises rates, your savings rate could go up. If the Federal Reserve drops rates, your savings rate could go down. These changes can occur at any time.
Savings accounts allow more accessibility to your money than a no-penalty CD since you can deposit money into a savings account at any time. However, there may be withdrawal limits to keep in mind.
According to Regulation D, you may only make six transfers from a savings account monthly. However, the Board of Governors of the Federal Reserve amended Regulation D during the COVID-19 pandemic, so banks may choose to suspend the monthly transfer limit so customers can make unlimited monthly transactions. The savings account disclosure agreement will specify whether a bank enforces transfer limits.
You could contact the bank's customer service to see if there are excess withdrawal fees for a particular savings account. An excess withdrawal fee is a charge applied by banks when a customer exceeds the six-per-month limit.
Comparing no-penalty CDs and savings accounts
When comparing a no-penalty CD and a savings account, there are two distinctions you'll want to pay close attention to: the Annual Percentage Yield (APY) and when you can deposit or withdraw money.
- A savings account is a type of bank account with a variable interest rate. Savings accounts generally offer more flexibility for deposits and withdrawals than a no-penalty CD.
- A no-penalty CD is a type of bank account with a fixed interest rate. These types of CDs do not charge early withdrawal penalties, but there still may be limitations for withdrawals and deposits.
Interest rates on both accounts
Interest rates do not take into account compounding, so when you're comparing CDs and savings accounts, it's important to look at the APY.
APY is the amount you earn in interest over the course of a year and is expressed as a percent.
Accessibility and withdrawals on both accounts
A no-penalty CD will have a specific term length, usually anywhere from three months to five years. During that time, you earn a fixed rate of return but typically can't add more money to your account. Sometimes, if you make an early withdrawal, your term will be suspended.
You can generally access a savings account at any time to add or withdraw money, though some banks will charge a fee for excess withdrawals.
Minimum deposit requirements on both accounts
Most CDs require a deposit of between $500 and $1,000, at a minimum. You can find several banks that allow you to open a savings account with $0 and start earning interest with just $1. In some cases, you may be charged a monthly fee on your savings account if your balance dips below a certain level.
FDIC insurance on both accounts
Both no-penalty CDs and savings accounts are federally insured up to $250,000 per depositor, per ownership account type, per institution in the event of a bank failure. To keep your money insured over $250,000, you could open an account with different ownership types — for example, an individual and joint bank account — or a bank with multiple institutions.
Fees and penalties on both accounts
There's no fee to open a CD or a savings account, but the latter may charge a monthly service fee, overdraft fee, or other common bank fees. Importantly, you won't be charged a penalty to withdraw your money from a no-penalty CD before your term is up.
Pros and cons of no-penalty CDs
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Pros and cons of savings accounts
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Which is better for you?
You'll likely prefer a savings account over a no-penalty CD if you want more accessibility to your money. With a savings account, you could deposit money at any time. For withdrawals (as long as you're mindful of potential withdrawal limits) you could easily move money from a savings account to a checking account.
How much you'll keep in a savings account will depend on your situation and savings goals.
Jerel Butler, a CFP professional and founder of Millenial Financial Solutions, suggests keeping three to six months of expenses in a savings account.
"If your monthly expenses are around $5,000, you would want to keep somewhere between $15,000 and $30,000 within a high-yield savings account," says Butler.
If you have additional available funds, Butler recommends considering investment options, which could include low-risk investments like CDs.
No-penalty CD vs. high-yield savings account FAQs
A no-penalty CD allows you to make a full or partial withdrawal before your term is up without paying a fee.
No-penalty CD rates and online high-yield savings account rates are competitive. You can find rates of 4% or higher on CDs and savings accounts right now.
Customers generally have full flexibility of withdrawals from a savings account. While some banks and credit unions impose a six-times-per-month transfer/withdrawal limit, customers can usually still complete transactions over the limit for a fee.
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