Published in: Banks | Oct. 5, 2019
By: Maurie Backman
CDs are more restrictive than savings accounts, so they may not be the best place for your emergency savings.
We all need money on hand for a rainy day, whether it's for a car breakdown, a home repair, or your employer telling you you're out of a job. In fact, your most pressing financial goal should be to build an emergency fund -- savings to cover three to six months of living expenses.
But where should you house your emergency savings? If you put that cash in a regular savings account, you'll earn some interest on it while you're not using it, but not a lot. On the other hand, if you stick it in a certificate of deposit, or CD, you'll earn a higher interest rate than a regular savings account will pay you.
Although that might seem like a better alternative, there's a danger to keeping your emergency cash in a CD.
When you put money into a CD, you agree to keep it there for a preset period of time. That timeframe could be one year, five years, or more. There are lots of options.
If you remove funds from your CD during its term, you'll be penalized. This usually takes the form of losing several months' worth of interest.
There are no legal penalties for early withdrawals from CDs -- they're at your bank's discretion. But to give you an idea, you could be penalized to the tune of three months' interest for a one-year CD. You could easily lose six months' interest for an early withdrawal from a two-year CD.
That penalty, by the way, will often apply whether you withdraw your entire CD or just a small portion of it. In fact, some banks won't let you take a partial withdrawal from a CD; rather, they'll force you to cash it out entirely if you need to tap it.
That's why a CD isn't the best place for your emergency savings. The point of an emergency fund is to have instant, stress-free access to cash when you need it unexpectedly. If you put your emergency money into a CD and end up withdrawing from it, you'll lose out on a large chunk of interest, negating the benefit of that CD in the first place.
If you have extra money in savings, then by all means, put it in a CD. But your core emergency fund should stay in a regular savings account where you can withdraw from it as you please without penalties.
Let's imagine you want an emergency fund of $9,000 and have $12,000 in cash on hand. In that case, it pays to put that $9,000 into a savings account. Stick the remaining $3,000 into a CD where it can earn added interest.
Housing your emergency fund in a CD isn't the worst decision. Although you'll lose out on interest if you wind up making a withdrawal, your original contribution to the account is protected from losses provided it doesn't exceed $250,000. That's because CDs are FDIC-insured.
Still, it pays to consider sticking with a regular savings account for your emergency fund. You earn interest on that cash and won't feel anxious if life happens and you're forced to withdraw money to cover an unplanned bill.
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