Why the No-Penalty CD Is the Ultimate Hybrid Savings Account

Photo illustration to accompany article on no-penalty CDs Getty Images

We want to help you make more informed decisions. Some links on our site — clearly marked — will take you to a partner website and may result in us earning a referral commission. For more information, see How We Make Money.

When it comes to savings accounts, no-penalty CDs can offer the best of both worlds.

Traditional CDs can be great long-term savings tools, but many people aren’t in a position to lock away any substantial amount of cash for an extended period of time, especially during a recession brought on by the coronavirus pandemic. And while high-yield savings accounts offer easy access, they aren’t always going to offer the best returns.

But a no-penalty CD is kind of a hybrid. These liquid CDs offer fixed, competitive rates along with the reassurance of easy access to your money, even if you withdraw early.

“They’re a nice middle ground option for people,” says Adam Stockton, director of consumer pricing at Novantas, a consulting and research firm that works with financial institutions. “Everyone has to make the trade-off of how much they value the rate versus the access to their funds, but it can be a best of both worlds option in some cases.”

What is A No-Penalty CD?

No-penalty CDs operate similarly to regular certificates of deposit—you agree to a term and lock in an interest rate upfront, then deposit your money and leave it until the CD reaches maturity. You won’t be able to add money to the account over its term; instead, your initial deposit is the principal that interest builds upon. 

But unlike traditional CDs, you’ll forgo any penalties for early withdrawal if you need to take out your cash before your CD reaches maturity. Typically, penalties for withdrawing from a CD early may include a percentage of interest earnings, your full interest earned up to that point, or even part of your principal. 

Depending on your bank’s specific rules, no-penalty CDs may allow a one-time withdrawal of your money (essentially closing your account) or, more rarely, partial withdrawals throughout the term. Be mindful of any waiting period your bank imposes, though; you may have to wait a few weeks after account opening before you can withdraw penalty-free.

So what’s the catch?

In exchange for more liquidity, you will likely give up some potential interest earnings with a no-penalty CD, compared to a long-term traditional CD. In today’s low rate environment, the difference between no-penalty CD rates and short- or even long-term CDs is marginal, but when rates do begin rising again, potential for lost interest is something to keep in mind. 

No-penalty CD term lengths options are also more limited: No-penalty CD terms typically range from about 6 months to 12 or 14 months, and many of the top rate offers on the market today are for 11-month no-penalty CDs. 

Pros of No-penalty CDs

  • Fixed interest: In times when interest rates are high, a no-penalty CD allows you to lock in a great rate and safeguard your interest if rates fall over your term.
  • Liquidity: Maintain the option to withdraw your cash at any point throughout your term. Check with your specific bank about one-time withdrawal limits or partial withdrawal allowances. If rates do begin to rise before your CD matures, you can take advantage of the opportunity to withdraw early and put it in a new account earning higher interest.
  • Security: Like other deposit products, no-penalty CDs are insured by the FDIC, up to $250,000.

Cons of No-penalty CDs

  • Fixed interest: In a rising rate environment, securing a fixed interest rate may cause you to lose out on potential interest earned. If rates rise throughout your CD’s term, you could miss out on those rates if you keep your money in the CD.
  • Lower APY than other CDs: Given today’s historically low rates, this isn’t as much of a concern, but in a world with more competitive interest rates, you’ll likely give up some yield by choosing a no-penalty CD over a traditional, less-liquid CD.
  • Initial deposit: Like other types of CDs, no-penalty CDs require you to deposit your principal at account opening. If you’re looking for an account that you can contribute to regularly while earning interest, consider a high-yield savings or money market account.
  • Minimum balance: Double check the minimum required balance to earn the advertised APY, as some no-penalty CD minimums can run steep.

Should You Open a No-penalty CD or High-Yield Savings Account?

Liquidity is a great perk of no-penalty CDs, but if accessibility is your biggest need, you may want to consider a high-yield savings account instead. And as rates continue to move under 1% across the board, sticking to a high-yield savings may even be the best option for earning interest in the current rate environment. 

Because accessibility of cash has become increasingly important throughout the past few months amid the pandemic, savers may see fewer incentives for CDs in general. Anjali Jariwala, CFP, founder of FIT Advisors in Redondo Beach, California, used to recommend a rolling short-term CD savings strategy to clients, but she says that’s no longer the best choice when cash is king and low rates dominate. 

But while she may not recommend clients tie up money in a traditional CD, she does still see no-penalty CDs as a viable option. “Before, there was a bigger differential with the no-penalty CD and the high-yield savings rate, but if they’re the same, I don’t see the difference in putting it in one versus the other.”

Choose A Savings Vehicle That Serves Your Needs

Consider what purpose you want the money to serve before opening any account.

For instance, if you’re looking for somewhere to keep an emergency fund to which you’ll contribute regularly, a high-yield savings or money market account is going to give you the most efficient and direct access to your money when an emergency arises. 

If you want an account to stow away money you have saved for going back to grad school in five years, however, a no-penalty CD can be a great set-it-and-forget-it savings tool that ensures liquidity if you decide to enroll sooner.

First determine your need, and it will be easier to decide on the right product to fulfill that need.

Consider Falling Rates

Another detail to consider in today’s economy is how falling rates affect no-penalty CDs and savings accounts differently, and the unique state of overall near-zero interest rates more generally. “In many cases, banks tend to move down their no-penalty CD rates even before their savings rates, kind of in anticipation of where the market’s going to go,” Stockton says.

For example, Marcus by Goldman Sachs and Ally Bank, which consistently offer among the highest interest available on the market, currently have lower rates on no-penalty CDs than on their high-yield savings accounts (which have also continuously fallen since the Fed’s emergency rate cut in March 2020). 

Despite being faster to drop, no-penalty CDs can still appeal to those who want to lock in what marginally higher rate they can as rates continue to fall.

“If you look back to a year ago, the no-penalty CD rates were consistently above savings rates,” Stockton says. “That may not be the case anymore, but it does certainly serve the dual purpose of protecting against downside risk in terms of the chances rates go lower, while also giving that option to cash out if the consumer needs it.”

Bottom Line

If you can score a competitive interest rate, no-penalty CDs are a great compromise between flexible high-yield savings or money market accounts and traditional CDs with fixed interest. 

But given today’s rate environment, you may find interest on savings accounts to be just as good, if not better than those available on CDs of any type. The most important thing is to do your research before opening any new account to find the right product that fits with your timeline, savings goal, and liquidity needs.