A certificate of deposit is a type of savings account in which the issuing financial institution pays interest on a specified amount of money for the initial deposit over a predetermined period. The duration can range from one month to five years, and even up to 10 years in some cases.
Intermediary Fees
When you purchase traditional certificates of deposit directly from banks and credit unions, intermediate certificates of deposit are purchased by brokers from external entities who sell them to you. When sold for the first time, they are referred to as “new issues” in the primary market. If you buy new issues, you typically won’t incur any fees because you are buying the intermediate certificate of deposit from the issuer through the broker. For these certificates, the broker usually receives a placement fee from the issuer.
However, when holders of intermediate certificates of deposit wish to withdraw their funds before maturity dates, they can sell them in what is known as the secondary market. If you purchase one of these certificates, your money goes to the current owner of the certificate of deposit instead of the original issuing entity, and you are likely to incur broker fees.
How Much Do Broker Fees for Certificates of Deposit Cost?
Fees vary from one broker to another, so it’s best to inquire before purchasing a certificate of deposit to find out if you’ll incur any fees and how much those fees will be.
For example, Vanguard brokerage services do not charge fees on new issues, but they do impose a fee of $1 for every $1,000 of the certificate’s value (up to $250) on intermediate certificates of deposit purchased in the secondary market. You will also incur a broker assistance fee of $25 on certificates of deposit traded in the secondary market over the phone. So, if you purchased an intermediate certificate of deposit valued at $250,000 from the secondary market over the phone with a Vanguard broker, you may have to pay $275 in fees.
How to Minimize Broker Fees for Certificates of Deposit
To reduce broker fees for certificates of deposit, look for brokers who do not charge fees or charge less than others. For instance, Merrill charges broker assistance transaction fees in the secondary market. However, Merrill’s fees are $29.95 per transaction. By choosing Vanguard, you can save $4.95 per transaction.
Note: When purchasing new intermediate certificates of deposit, you generally see fewer fees, if any, which can help you save more money. Conversely, if you decide to buy an intermediate certificate of deposit in the secondary market, you can often reduce fees by conducting the transaction online without phone assistance from the broker.
Early Withdrawal Fees
Early withdrawal fees, also known as early withdrawal penalties, are the fees you must pay if you withdraw funds from a certificate of deposit before its maturity. For example, if you invested $1,000 in a one-year certificate of deposit but needed the money after six months, you are likely to face a penalty for early withdrawal.
How Much Do Early Withdrawal Fees for Certificates of Deposit Cost?
These fees can vary from one certificate of deposit issuer to another and can also vary between certificate products from the same issuer. Typically, the longer the term of the certificate of deposit, the greater the penalty you will face. In many cases, penalties are based on a number of months or days of interest that you forfeit.
Here’s an example of penalty amounts:
- Certificate of deposit for 12 months or less: 90 days of simple interest at the current interest rate
- More than 12 months but less than 48 months: 180 days of simple interest at the current interest rate
- 48 months or more: 365 days of simple interest at the current interest rate
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In this case, if you place your money in a certificate of deposit for one year but withdraw it before maturity, you will have to pay an amount equivalent to 90 days of interest.
How to Avoid Early Withdrawal Penalties on Certificates of Deposit
There are several ways you can follow to avoid or reduce early withdrawal penalties on certificates of deposit:
- Don’t commit more than you should: The first way to avoid early withdrawal penalties is to choose a term for the certificate of deposit that you know you can commit to until maturity. If you have any doubts about the length of time, opt for a shorter term.
- Explore liquid certificates of deposit: A liquid certificate of deposit is a type of certificate that has no early withdrawal penalties. This may be a good option if you think you might need to withdraw funds early. However, they typically come with a lower annual yield.
- Use CD ladders: CD ladders are a strategy that involves staggering your CD investments so that they mature at regular intervals. This can help you avoid early withdrawals while maintaining a higher annual yield.
- Shop around: Some banks may impose higher penalties than others. When choosing a certificate of deposit, you can minimize penalties by shopping around and opting for a certificate that imposes lower fees.
Taxes on Certificate of Deposit Interest
The third cost you will face with a certificate of deposit is the tax you will pay on the interest you earn. Interest income from certificates of deposit is considered taxable income in the year it becomes available to you. If the certificate of deposit lasts more than one tax year, you will report the interest earned at the end of each year, even if you haven’t withdrawn it yet.
Note: You will not pay tax on the entire amount of the certificate of deposit, only on the amount of interest you earn from the certificate each year.
How Much Do CD Interest Taxes Cost?
Interest income is added to your other income and is taxed at ordinary income tax rates. The amount you will owe will depend on your tax bracket. For example, if you are filing your tax return as a head of household and you earned $50,000 from your wages and $100 from your CDs in 2022, you will be taxed at 10% on the first $14,650 you earned and at 12% on the remaining amount.
How to Reduce CD Interest Taxes
There is not much you can do about the taxes on your interest income. The more interest you earn, the more taxes you will pay. However, you can deduct any fees incurred by the issuer of the certificate of deposit.
Frequently Asked Questions (FAQs)
Here are some frequently asked questions about certificates of deposit:
Can I deduct early withdrawal fees from my CD from my taxes?
Yes, you can deduct early withdrawal fees from your taxes. If early withdrawal fees were assessed, you will receive a 1099-INT notice or a similar statement reporting both the interest earned and the amount of the penalty fee. You can deduct the penalty amount by entering it on line 18 of Schedule 1 (Form 1040).
When my certificate of deposit matures, do I have to pay a fee to transfer my funds?
When your certificate of deposit matures, you should not have to pay any fees or penalties to transfer your funds. However, be sure to confirm this with the financial institution that issued the certificate before enrolling, to avoid any unexpected fees.
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Source:
https://www.thebalancemoney.com/certificate-of-deposit-costs-5224826
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