CD Redemption Features

Redemption features of CDs include those that reach an agreed upon maturity date and those that are callable. The maturity date of a CD can range from 6 months to 10 years, although businesses often buy CDs for longer periods. A CD that expires at maturity can either be cashed out or renewed following the grace period. A CD with call features, however, can be called away by the issuing bank at any point. This type of CD will usually pay a higher rate than one that simply expires at maturity because of the increased risk.

Both of these CDs can have a place in an investor's portfolio but each meets much different financial goals. The information below will help you determine which is right for you.

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Certificate of Deposit Maturity Date

A certificate of deposit is in effect a contract. In exchange for a fixed or variable rate of interest, the purchaser agrees to hold the CD for the entire length of the term. If the purchaser redeems the CD early, the bank has the option of charging a penalty for the early withdrawal.

CDs that reach their "natural" maturity date can either be redeemed or rolled into a new CD. The bank will typically allow a grace period of 10 to 15 days in which the investor can decide what to do with the money. Some banks will automatically roll a mature CD into a new one if the investor does not take action.

A CD with the maturity redemption feature is best for people who need to make sure that their investment will continue to earn the agreed upon rate of interest for the length of the term. If a CD is part of a long-term plan for the purpose of buying property, a child's education, or even an emergency fund, one that has a traditional maturity redemption feature is often the best choice.

Callable Certificate of Deposit

A callable CD is one that can be called away from an investor once the call-protection has expired but prior to the CD maturity date. It's important to remember that the callable feature only works one way. The bank can choose to end the contract before the maturity date as long as it pays the principal and any interest that has yet to be credited. The purchaser, however, does not have the right to exit the contract early without penalty. Banks are more likely to call a CD if interests rates drop. In other words, if the bank issued a 5-year CD at 3.0% two years ago but is now issuing 5-year CDs at 2.75%, they may call the CD paying the higher rate.

The callable CD is the reverse of the bump-up CD. Rather than getting paid a lower rate for the right to receive an increase in the rate before the maturity date, the owner is paid a higher rate to compensate for the potential of having the CD called away. Callable CDs should be considered as investments and not as saving vehicles. Investors can earn higher rates over longer periods of time, but if the CD is called away, he or she will be left to purchase a new CD at a lower rate.

Callable CDs Purchased from a Broker

Because callable CDs are more of an investment product than a savings product, brokerage houses often sell them in conjunction with equities and bonds. If you've purchased a callable CD, you'll want to make sure that the interest paid on other CDs and investments is protected in an environment of dropping interest rates. In other words, once the CD is called away, the interest rate paid on a new CD may be too low to offset the effects of inflation. Therefore, an investor should always consider how a callable CD fits into the overall investment portfolio.

Other Considerations of a Callable CD

If you've purchased a CD from a brokerage house, you need to ask where it will be held. All certificates of deposit are FDIC insured because they are issued by and the responsibility of a bank, even if sold by a broker. However, if the CD is held at a bank in which the owner has existing accounts, it may not be covered for the full amount.

Each bank depositor is insured up to $250,000. If an investor has savings and checking accounts at the bank at which the CD is held, the totals of these accounts and the CD will be added together if the bank fails. If the total exceeds the insurance limit, it's possible that the depositor will not receive full protection.

Early Withdrawal Penalties

While CDs are short- to medium-term investments, there may be times when the owner needs to withdrawal money prior to the maturity date. If this happens, the bank will normally charge an early withdrawal penalty. Penalties vary from bank to bank and range from a simple loss of interest to a loss of principal.

CD Redemption in the Event of the Death of the Owner

Regardless of the redemption features, a CD purchased from a bank will normally come with a payable-on-death (POD) option. This works similarly to the death benefit paid to a beneficiary of a life insurance policy. Upon the death of the owner, the full face value of the CD is paid to the beneficiary without having to pass through probate. There are no early withdrawal penalties if the owner dies prior to the maturity date.

A CD that is purchased through a broker also offers early redemption protection in the event of the death of the owner. The "survivor's option" allows the estate or the beneficiary to redeem the CD at par plus any accrued interest.

Choosing the Right Redemption Feature

Whether choosing a CD with a maturity date or a callable date, it's important to make sure that the CD fits into your overall financial plan. Older investors, especially those that have already retired may want to avoid callable CDs if it puts them in a position of earning less on the investment with dropping interest rates. Younger investors are typically better able to ride out any rough patches over time. While CDs that have a fixed maturity date may not earn as much interest, they can at least provide a balanced approach to interest income.

While we've covered the basics of CD investing here, CDs should only be part of a long-term investment strategy. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.

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