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Q:
Please warn your readers about the outrageous early
withdrawal penalties some banks are charging on CDs. My
husband and I decided to cash in a CD to use for a down
payment on a home. The 13-month CD had renewed in late
July, and we expected to get hit with a loss of three
months in interest as a penalty. Imagine our shock when
we were told that there was a 3 percent penalty for
early withdrawal — this on a CD earning just 0.2
percent. Absolutely outrageous! Why on earth would
someone knowingly invest in a CD with a penalty more
than the interest? We would have been better off putting
our money under our mattress.
—C.B.
A:
This is outrageous, and here is the warning: If there is
any chance that you will need to pull your money out of
a CD early, make sure you understand clearly what the
penalty will be. And if you are going to renew a CD,
make sure you don’t do it without reviewing the terms.
We
all get busy, and sometimes it seems easier just to let
a CD go on autopilot when a due date arrives. But as you
point out, that can cost you dearly.
The
typical penalties for CDs usually are not terribly
painful. According to Bankrate.com senior financial
analyst Greg McBride, on a one-year CD you usually lose
three months of interest if you take your money out
before the due date. It’s usually six months if your
CD matures in more than a year.
But
you can’t assume that will be the case with every CD.
In a survey of banks last year, Bankrate.com found that
92 percent would dip into your principal to cover the
penalty. In other words, you are right: Putting money
under the mattress could be a better deal, at least if
you could be sure your home wouldn’t catch fire.
And
McBride said he thinks banks might be more likely to
assign penalties now because interest rates are low and
won’t stay there indefinitely. You can bet that the
moment there is any chance of earning more interest than
today’s starvation rates, people will jump, fleeing
old CDs as fast as they can. So the banks want to make
sure that when interest rates rise, they aren’t caught
by a flood of customers yanking money out of CDs and
depositing the money elsewhere.
In
fairness to the bank, McBride said, you should realize
that when you buy a CD, your money isn’t sitting in a
bank waiting for you to remove it. The bank lends it to
other people for cars, mortgages, businesses or other
purposes. The bank plans to have cash available when
it’s time for your CD to mature. But if there is a
sudden change, and a lot of people want their cash
unexpectedly, that’s a problem for the bank, McBride
said.
Still,
a 3 percent penalty on a CD that pays almost no interest
is shocking. Other banks might be doing the same. So
always ask before you leap and get it in writing.
Q:
I work with someone who wants to take money out of her
401(k) and use it for a down payment on a house. She
says she will pay it back, and it’s like paying
interest to yourself. But I always heard that you had to
leave your money in a 401(k) until you retire. Can my
friend do what she wants to do?
—R.J.
A:
You are typically allowed to borrow half your 401(k)
balance, up to $50,000. But that’s not as simple as it
looks. You have to repay the loan with interest, and if
you lose your job, you generally have only 60 days to
pay everything back.
If
you fail to do so, you will have to pay income tax on
everything you owe. In addition, you will have a 10
percent penalty. Paying such high costs is the last
thing anyone wants when they are out of a job.
And
in the current environment, everyone needs to think
twice about the risk, because few jobs are a certainty
and finding a new one is tough.
Even
hardship withdrawals, which people are using now because
of financial troubles, have consequences. They do not
have to be repaid, but you must pay income taxes and,
generally, a 10 percent penalty on the withdrawal in
that tax year. And if you are in a tough financial
situation, taking a hardship withdrawal is especially
unwise. That’s because if you leave the money in a
401(k), it is protected from creditors. The government
wants it safe so you are not poor when you retire.
Too
many people are taking money from 401(k)s in a desperate
move to save their homes. This can be a disaster. Often,
they still can’t save their homes, and they give up
retirement money they will need someday. If they had
gone bankrupt and had money in their 401(k), the court
wouldn’t have touched that money.
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