Try the CD splitting strategy to reduce your risk

By Sabrina Karl

It’s a simple contract: Deposit money in a certificate of deposit and leave it untouched for a fixed period, and the bank will pay you a higher interest rate than you’d earn from a savings account. Break the contract by removing the funds too soon and you’ll pay an early withdrawal penalty.

For those feeling certain they won’t need their funds during the CD period, the risk is inconsequential. But if you’re not quite as confident, or you’re willing to accept a slight administrative burden in exchange for minimizing any earnings impact should you need to “break” your CD early, a splitting strategy can be smart.

Splitting CDs simply means opening a number of smaller CDs rather than a single certificate. Say you’ll be investing $20,000. Instead of opening one $20,000 certificate, you can opt to open two at $10,000 each, or four at $5,000 each, or even 10 at $2,000 each.

The advantage is simple. If you unexpectedly need to access some, but not all, of your funds, you can break just one or two CDs (or however many you need) instead of the whole lump sum. This limits your penalty to what you actually withdraw, leaving earnings on the rest unscathed.

Since most CDs are fee-free, there’s no added cost to opening multiple certificates. You will, however, incur more paperwork since each CD will receive its own statement. In these days of electronic statements, however, it’s a minor trade-off.

You’ll also want to check a bank’s minimum deposit requirements. Though many offer CDs with minimums of $1,000 or even $500, some require $10,000 or more. So check terms carefully as you shop around.

CDs are a great way to maximize earnings on your unneeded cash, and by splitting certificates, you can minimize your risk at the same time.

Are there are fees to open or maintain a CD?

By Sabrina Karl

If you’ve noticed the news stories over the last several years about the rising frequency of bank fees, and are considering stashing some of your savings in a certificate of deposit, you might wonder what fees you could encounter with a CD.

The good news is that it’s a rare CD that will hit you with any fees.

With the basic model of a certificate of deposit being that you agree both to invest a certain dollar amount with the bank or credit union for a predetermined number of years and not withdraw the funds until the term expires, there are almost no transactions involved with a CD, other than its inception and maturity.

As a result, banks generally don’t charge any fees for opening a CD, nor for maintaining it through its term.

That said, a couple specific instances could incur a fee or penalty in your CD account. The most common is the early withdrawal penalty, which is triggered if you withdraw any of the CD’s balance before maturity.

Each bank’s early withdrawal penalty is self-determined, and is typically calculated as a number of months’ interest deducted from the CD’s balance before the bank returns your funds. But the penalties vary widely, so it’s important to check a bank’s policy before opening a certificate with them.

Another fee that a small number of CDs charge is for paper statements. Occasionally, a CD will carry a condition that only electronic statements are allowed — it might even be called an eCD. So requesting paper statements could land you in monthly fee territory.

For the vast majority of CD savers, though, the experience will be fee-free: you’ll deposit your funds, let them sit and earn interest for the term, and withdraw the principal and earnings in full at the end.

Is a CD a good place to keep emergency funds?

By Sabrina Karl

You’ve heard the advice dozens of times: Establish an ample emergency fund so you can weather life’s financial surprises. But is a savings account the only smart place for these rainy day funds?

The answer is no. Sure, a high-yield savings account can be a great choice, giving you unfettered access to your money while earning a little interest. But stashing your savings in a certificate of deposit can be even smarter, since it’ll earn a greater return.

True, CDs aren’t as flexible as savings accounts. But their restriction on withdrawals can be helpful if it fends off your temptation to tap the funds. Plus, if you choose your CD right, accessing the funds in an emergency won’t carry a huge price tag.

But won’t you be hit with an early withdrawal penalty if you cash in the CD before its maturity date? Yes, but shopping around is key. Not all early withdrawal policies are created equal, and it’s not hard to find a CD with a mild or moderate penalty.

Also remember that this is money you’re socking away for an emergency, not to withdraw willy nilly. So because your odds of needing to access the funds are low, a reasonable early withdrawal penalty can be worth the risk.

Still, if you’re wary of putting all your emergency funds into a CD, opening multiple certificates enables you to cash out just a portion of your CD funds rather than all of it. Or, put some into a savings account so you’ll always have ultra-quick access to a portion of your money.

If you’re saving the recommend 3 to 6 months’ living expenses in an emergency fund, it makes good sense to maximize your return while that money sits idle, and CDs can provide an excellent means to that end.

What is a CD grace period?

By Sabrina Karl

When you open a certificate of deposit, you’re entering into a contract with the bank or credit union to keep your funds deposited with them, earning a specified rate of return, for a set period of time.

That period is always explicitly defined by an end date, called the maturity date. And once that date hits, something will happen with your CD funds. What happens depends on instructions you make, or on the bank’s policy if you fail to provide any guidance.

The issuer of your CD will notify you when your CD is soon maturing. In that notification, they’ll indicate their policy on handling maturing funds if you do nothing. Most will roll the funds over into a new CD of a similar term and at current rates, while a smaller share of institutions will move the funds into a linked savings account.

The notification should also stipulate the grace period, which is the number of days after the official maturity date – usually one to 10 – during which you can still make instructions. After the grace period ends, your opportunity sunsets on deciding your own terms for handling the funds, and the bank’s default policy instead takes effect.

It’s always best to act before the maturity date, so you can direct the bank to move the funds into savings, or return them to you by check, or even transfer them to another institution. But should you miss that deadline, the grace period gives you a little cushion to still make a smart decision.

Note, however, that your CD will stop earning interest on the maturity date, regardless of entering the grace period. Your grace period provides only an extension for decision-making, not an extension of your interest-earning period. So funds will earn nothing during the grace period.

Can you invest IRA funds in a CD? And should you?

By Sabrina Karl

Certificates of deposit can be a great tool for saving toward a short-term goal, like building up a house down payment or stashing money for a big project or dream vacation. But what about retirement? Do CDs have a place in saving for your golden years?

The first question is whether CDs are an allowable retirement investment, and the answer is yes. When you open an Individual Retirement Account, or IRA, that account is simply a container, which can hold most types of investments, from bank deposits like CDs to stocks and bonds.

Opening an IRA CD is hardly different than opening a regular CD. At most banks and credit unions, all the CDs in their regular menu are equally available in an IRA. The difference isn’t usually in the CD itself, but simply in the account where you hold it.

Occasionally, however, an institution will promote a specific IRA CD offer. These are often longer-term certificates, which typically come with a more favorable rate.

But are retirement CDs a good idea? It’s true that CDs are extremely safe and entirely predictable, so they’re well-suited well to savers who have almost no risk tolerance or a strong aversion to investing in stocks and bonds.

But since a CD’s fixed rate of return generally lags these other investments over the long term – and usually significantly – investing your IRA funds in a CD will earn you far less over time. And in order to grow your nest egg sufficiently to fund your retirement years, the more substantial gains earned in the stock market are likely to be necessary.

That said, for savers who are very close to retirement, or who wish to hold a portion of their retirement savings outside the stock market, IRA CDs are indeed safe and reliable.