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updated 2/25/2010 12:12:35 PM ET 2010-02-25T17:12:35

Savers who dump low-yielding CDs before maturity may pay a steep price, according to a Bankrate survey of early withdrawal penalties at 100 institutions.

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Almost all of the institutions surveyed — 92 percent — not only levy a penalty, but also reach into principal to cover fees if necessary.

That was just one of the findings in the Bankrate survey, which looked at the top five banks and top five thrifts by deposit size from the top 10 markets nationwide. Also included in the survey were the top five credit unions, by assets, from across the country.

It was the first Bankrate survey of early withdrawal penalties since 2006.

According to Bankrate's research, the typical early withdrawal penalty for a CD with a maturity of one year or less is three months' worth of interest.

For a CD with a maturity of a year or more, the typical early withdrawal penalty equals six months' worth of interest.

Some institutions wallop investors with especially heavy penalties for early withdrawals. According to Bankrate's survey, it's not always the highest-yielding CDs that sport the most punishing penalties, as the following chart shows:

Most institutions surveyed also reach into the principal of savers who withdraw from CDs early, but haven't yet earned enough interest to cover the penalty fees. This could result in negative returns for some savers.

For this reason, it may be a mistake for savers to purchase a longer-term CD simply to capture a higher interest rate if they plan to exit the CD early — and pay a penalty — when yields rise.

In a rising rate environment, savers instead should consider "favoring shorter maturities to have the flexibility of reinvesting as interest rates rise," says Greg McBride, senior financial analyst at Bankrate.com.

The Bankrate survey also found that most retirement CDs also are subject to early withdrawal penalties. More than 80 percent of the time, the penalties for retirement CDs are identical to nonretirement penalties, according to the Bankrate survey.

Plan ahead
The good news is that with just a little planning, CD investors can avoid early withdrawal penalties and still enjoy higher yields once interest rates rise.

The first step is to determine your time horizon, McBride says. It's important to determine how long you can live without the money.

To avoid the temptation of tying up money longer than you can afford simply to chase a higher yield, do the math and find out how much you would lose by cashing out early.

McBride compares two CD maturities and returns — a six-month CD yielding 1.3 percent and a one-year CD yielding 1.6 percent.

"The additional 30 basis points doesn't begin to compensate for the six-month interest earnings penalty if you have to cash out early," he says.

Purchasing liquid CDs may be one way to avoid an early withdrawal penalty if you plan to dump today's sluggish CDs for higher-yielding replacements once rates rise.

Liquid CDs offer relatively low yields when compared to standard CDs of the same maturity. However, they also offer the convenience of penalty-free withdrawals — typically after an initial seven-day period.

Currently, liquid CDs are not widely available — only 21 institutions out of the 100 surveyed offer them. None of the credit unions Bankrate surveyed offers liquid CDs.

Know the terms
McBride says it is important to examine the terms of a liquid CD closely before purchasing this type of product.

"Terms vary widely, so be sure to know the specifics before investing," he says.

"Also, gauge the difference in yield on the front end versus non-liquid CDs," he says. "You may be better off with a traditional CD of a shorter maturity."

For a dedicated fixed-income investor, liquid CD yields may not be high enough to make them worthwhile.

Donald Cummings, managing partner at Blue Haven Capital in Geneva, Ill., recommends investors skip liquid CDs.

"The investor is paying for liquidity and that liquidity is something that the investor can create for himself," he says. "The opportunity cost is way too high."

If liquidity is priority, a high-yield money market account could be another option for short-term savings.

Cummings also recommends savers build a CD ladder into their portfolios. This allows them to keep some liquidity while also taking advantage of some of the higher yields on longer maturities.

"If one thinks we will have moderate, sustained interest rate increases starting six months from now and continuing quarterly for the next few years, I say ladder the portfolio out to about six or seven years, with the bulk of the investments in the three- to five-year sector," he says.

"The investor ends up moving out a bit on the curve in a couple years when rates presumably are up another 1 percent or so, yet has kept liquidity and captured some of the longer rates available out on the curve," he says.

To learn more about CDs, check out Bankrate's 2006 early withdrawal penalty study and the 2008 survey of where to find the best CD rates.

© 2012 Bankrate.com

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