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CDs as Bond Bubble Protection - Revisited

Buying high yielding certificates of deposit with easy early withdrawal penalties give consumers a higher yield, less default risk, and more downside protection against rising interest rates. These CDs protect us against a possible bond bubble.

Several people, however, have pointed out a flaw in the strategy in that the bank or credit union can unilaterally change the terms of the CD, including the early withdrawal penalty. Ken Tuman, founder of, alerted me to some comments on their site regarding early withdrawal concerns. One comment specifically mentioned that Fort Knox Federal Credit Union in Fort Knox, Kentucky, unilaterally changed the terms of existing CDs. Readers wondered what the positions of the regulators were on this.

Can institutions change CD terms?
One key to the CD strategy is that, if interest rates rise dramatically, consumers would want to pay the early withdrawal penalty and reinvest the funds at a higher rate. If the bank or credit union decides it wants to change the terms of the CD and not allow the early withdrawal, then the protection against the bond bubble is wiped out, since funds would be stuck at the bank or credit union until maturity.

My response to people was that, while I'm not an attorney, the CD terms are a contract between the consumer and the institution. Contract law states that an executed contract cannot be changed unless both parties agree to such a change. Dan Solin, attorney, advisor, and author, agreed with my assessment.

Regulators weigh-in
There was enough buzz about changing terms of existing CDs that I spoke to both the FDIC, which regulates banks, and the NCUA, which regulates credit unions. FDIC spokesperson, David Barr, looked into the matter and said all of the terms of an executed CD were binding. NCUA spokesperson, Cherie Umbel, also reached the same conclusion for credit unions. Thus, in the eyes of the regulators, no institution can unilaterally change the early withdrawal terms.

Fort Knox Federal Credit Union Responds
I was able to reach a Michael Bateman, a spokesperson for the Fort Knox credit union, and referred him to the comment regarding their unilateral change of the CD terms. Bateman assured me that they abide by the terms in the agreement, and those terms give the consumer the right to an early withdrawal of funds with a 90 day interest penalty, whether earned or unearned.

I asked for the specific disclosure and found it said "withdrawal of the principal amount of your certificate may be made only with the consent of the Credit Union." Bateman said the terms were on pages 33 and 34 of the membership agreement. I doubt many members actually understood this and, to me, this seems to resemble some tricky annuity disclosures I've written about. Bateman stated that no CD disclosure is provided, as the member is bound by the membership agreement.

Importance of reading CD disclosure terms
Dan Solin noted the importance of reading the CD disclosure terms appropriately saying "the devil is in the details." If the terms give you the right to make an early withdrawal, then those terms are binding. But if the terms say that the institution has the right to deny an early withdrawal or increase the penalty, then you want to avoid these institutions for funds you might pull out before the CD matures.

Some banks, like Capital One Bank, have a penalty called "economic replacement value," which essentially increases the penalty as interest rates move higher. I suspect I am to blame for this penalty, as many years ago I pointed out to the Chairman's office that their five year CD cashed out in one year was paying much higher than their one year CD. Shortly after that conversation, Capital One changed the early withdrawal penalty terms.

My Advice
Read the CD disclosure terms before opening any account. They are usually no more than a few pages and are like second grade reading compared to an annuity disclosure. If there is a separate membership agreement, as in the case of Fort Knox Federal Credit Union, make sure you look up any language on early withdrawals. It's critical to have the right to get out of a CD with acceptable terms. The easier the early withdrawal penalty, the better. Two institutions that I think currently have attractive rates and terms are:

  1. Ally Bank 5-Year CD paying 2.49% APY with a 60 day early withdrawal penalty - even if you keep it for only four months, you earn more than any money market account.
  2. Pentagon Federal Credit Union with seven year CD paying 3.49% APY with a penalty of the most recent year's interest. To qualify for membership, you may have to pay a one-time fee of $20 to join the National Military Family Association for one year.
In summary, it seems the CD strategy to earn higher rates, and get free protection against the bond bubble, passes the regulatory test in that institutions must honor the terms of any CD when it is opened. I cannot express strongly enough the importance of reading those terms and keeping a written copy.

More on MoneyWatch
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Four CDs That Protect Against a Bond Bubble
Best CDs - Where to find them

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