Think Twice Before Opening a CD for Your Emergency Fund—Here’s Why

Certificates of deposit can be a tempting option for parking a lot of money, like an emergency fund, since they offer higher returns on your savings, but CDs usually penalize you for withdrawing funds early. You need your emergency fund in an account that is liquid, so we’ll walk you through some better alternatives, like high-yield savings accounts.

CDs and Penalties

A CD has a few advantages over a standard savings account. Mainly, you’re guaranteed a return on your savings because there’s a fixed annual percentage yield (APY), unlike the APY for a savings account, which can change at any time. Also, the APY is usually much higher than what’s offered with a standard savings account. For instance, the money in a top-ranked CD could earn over 4.00%.

However, there are some disadvantages to CDs. You don’t have easy access to the money, which is a huge concern if the money is your emergency fund. You can withdraw funds before the CD term expires but be prepared to pay a hefty early withdrawal penalty. These are typically equal to a portion of the interest you’ve earned. For example, CDs with longer terms might charge the equivalent of three to 12 months’ worth of interest.

Where You Should Keep Your Emergency Fund

Most financial experts agree you should have at least six months’ worth of expenses set aside for emergencies. Our analysis estimates this to be around $33,110.68, on average. While that might seem like a lot, it should cover six months’ worth of housing bills, utilities, medical payments, food, and car expenses. You can build that fund over time by making regular deposits.

If an emergency comes up, you need to be able to access your money immediately, so the account should be liquid and separate from your primary checking account, so you’re not tempted to dip into the funds when it’s not an emergency. Regardless of the bank or account you choose, the funds should be insured by the FDIC (or the National Credit Union Administration if you choose a credit union) up to $250,000.

Here are some solid alternatives for parking your emergency fund:

High-Yield Savings Account

These savings accounts have higher yields than traditional savings accounts. Some are even competitive with the rates offered by CDs, but you have easy access to your funds. You can open a high-yield savings account in person or online through a bank or credit union.

Traditional Savings Account

These basic savings accounts might not have the best rates, but you might find this the most convenient option since you can open an account with a bank or credit union that you currently have a checking account with.

Money Market Account

A money market account is like a cross between a savings account and a checking account. Some offer rates competitive with the highest-paying savings accounts, but they also include check-writing capabilities. Just be sure to treat the money market account like savings and maintain a separate checking account for regular expenses.

Short-Term CD

Quick access to an emergency fund is paramount, but if you have six months’ worth of savings, a 3-month CD might be a good compromise if it offers higher rates than available high-yield savings options. This way, half of your emergency fund will be immediately available and the other half will be available within no more than three months.

The Bottom Line

It’s easy to see the appeal behind putting your emergency fund in a CD. This large amount of savings is guaranteed a great return, but remember, you don’t have easy access to your funds and you might pay a steep penalty for withdrawing money before the term ends. Fortunately, you have better options that still give you a high rate of return with the flexibility you need for an emergency fund.