Early withdrawal penalties are fees charged by financial institutions or the government when an investor withdraws money from long-term investment plans before they expire. Tax-deferred retirement plans and certificates of deposit (CDs) are subject to these fees, with exceptions for death or medical expenses. CD withdrawal penalties vary by bank and can include invading the principle.
An early withdrawal penalty is a fee charged by the government or a financial institution when an investor withdraws money from long-term investment plans before they have expired. These fees apply to two different types of investments: tax-deferred retirement plans and certificates of deposit (CDs). Roth IRAs, annuities, and 401k or 403b plans are examples of tax-deferred retirement plans subject to early withdrawal penalties.
Most government-sanctioned retirement plans follow the same basic guidelines. A beneficiary must have reached the age of 59.5 to be able to withdraw money from a Roth IRA, annuity, 401k or 403b account. If for any reason the beneficiary chooses to withdraw the money before turning 59.5, they will be charged an early withdrawal penalty of 10 percent of the investment value. In addition, the beneficiary is expected to pay taxes on the money that has been withdrawn.
There are certain exceptions under which the beneficiary may not have to pay the early withdrawal penalty. For example, if the beneficiary dies, the investment will be paid to the spouse or other family member without penalty. Also, if the beneficiary gets sick and needs money for medical expenses that add up to 7.5 percent more than what the beneficiary earns in a year, it is possible to take a deduction for medical expenses without paying the early withdrawal penalty. Other exceptions may also apply.
A CD is much like a savings account in that it is insured and almost risk free. The difference is that once the money is deposited into the CD, the bank or other financial institution expects it to stay there for an agreed period of time. In return, the bank agrees to pay the investor a higher interest rate than it pays on savings accounts. CD terms range from three months to five years. If money is withdrawn before the contracted time has elapsed, the investor will be charged an early withdrawal penalty.
The amount of the early withdrawal penalty varies from bank to bank. There is no mandatory maximum penalty at the federal level. Withdrawal penalties are generally based on the interest on the CD. For example, a bank may charge three months of interest for early withdrawals on a one-year CD.
Some contracts may allow the bank to invade the principle. This means that if the penalty is three months of interest and the investor takes money out of the CD after two months, the bank can take the rest of the money up front.
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