Here's What Happens if You Cash Out a CD Early

It's a situation you may want to try to avoid.

You may have money earmarked for emergency expenses, and that cash should sit in a regular savings account so it's accessible to you at all times. You may also have money you're saving for a far-off goal, like retirement. That's money you should invest in a brokerage account or IRA.

But some of your money might fall into an in-between category of sorts. You might, for example, have money you're setting aside for a shorter-term goal, like buying a house in three years. In that case, you shouldn't invest that money, because you may not have enough time to recover from a potential market downturn.

At the same time, you may want a higher return on that money than what a savings account will allow for. And that's where a certificate of deposit, or CD, might come in.

The upside of a CD is that you'll generally be eligible for a higher interest rate on your money than in a regular savings account. The downside, though, is that you have to commit to keeping your money where it is for a preset period of time. That time frame could be six months, 12 months, two years, or longer.

Now, this doesn't mean you can't cash out your CD before it matures if you end up having a pressing need for that cash. But doing so will commonly result in a penalty. And that penalty could be pretty steep.

What are the penalties for cashing out a CD early?

When it comes to setting penalties for cashing out a CD before it comes due, each bank makes its own rules. But to give you a sense of the penalties you might looking at, Wells Fargo follows this penalty schedule:

• You'll lose three months of interest on a three- to 12-month CD.
• You'll lose six months of interest on a 24-month CD.
• You'll lose a year's worth of interest on a CD whose term is longer than 24 months.

You should also know that it doesn't matter whether you remove a small portion of your CD or your entire balance. In fact, you generally can't just take a withdrawal from a CD -- you have to either leave it as-is or cash it out entirely.

So, let's say you've put $5,000 into a 12-month CD, and you need $500 of that in a pinch. You're still going to face a three-month penalty (if you bank at Wells Fargo or an institution that follows the same penalty schedule) even if you don't need all of the money in your CD.

How to avoid penalties for cashing out a CD early

One of the best ways to avoid being penalized for cashing out a CD ahead of schedule is to carefully consider the term, or length, of your CD before opening it. If you're not sure you can manage to keep your money tied up for 12 months straight, opt for a six-month CD instead.

Another option is to build a CD ladder rather than put all of your money into a single CD. With this approach, instead of putting $5,000 into a single CD, you might break that sum up into four separate CDs worth $1,250 apiece. You might then put your first $1,250 into a three-month CD, your next $1,250 into a six-month CD, the following $1,250 into a nine-month CD, and your final $1,250 into a 12-month CD.

With this setup, you'll have money getting freed up every three months. And at that point, you can decide whether you want to roll it into another CD or access your cash.

Sometimes, early CD withdrawals are unavoidable. But you can definitely take steps to lower your risk of getting hit with a penalty for accessing your cash before you're supposed to.