Why Do Credit Unions and Banks Charge Penalties for Early Withdrawal?
Credit unions and banks make money from interest payments on loans they provide to members or clients. One of the sources for those funds they lend out is member or client deposits. For-profit banks generate profit from the money their clients have in savings and checking accounts, while not-for-profit credit unions reinvest the funds they generate from interest payments into overhead expenses and making their products cheaper for all members (and paying higher yields on savings).
In other words, when you withdraw money from accounts, you’re taking away funds that the bank or credit union could lend out. By taking away that money, you’re reducing the potential interest they could earn from loans they’d issue with your money.
That’s why they incentivize savings in savings and checking accounts by offering a yield on account balances. Fixed-term accounts often have much higher balances than the average savings or checking account, meaning more funds to lend out. Banks incentivize saving in those types of accounts by offering even higher yields and discourage early withdrawals by attaching penalties.
For some fixed-term accounts, like traditional share certificates or certificates of deposit (CDs), the only penalty is losing the interest you would have earned had you left the funds in the account for the full term, although this can vary between institutions. Other types of savings accounts, like fixed annuities or brokered CDs, might charge higher fees or penalties in addition to losing interest.
How these penalties are structured can vary depending on the type of account and the institution. For example, fixed annuities, which are offered by insurance companies, charge a “surrender” fee if money is withdrawn in the surrender period. This is designed to discourage withdrawals in the early years after the fixed annuity is purchased and is typically a percentage of the withdrawn funds. The percentage penalty decreases as the surrender period nears its end. A saver might be charged seven percent of the withdrawn funds in the first year after they purchase the annuity but only two percent on withdrawn funds in the sixth year.
Another way banks discourage savers from taking out money is by limiting the number of withdrawals and transfers you can make for free from certain types of accounts each month. These limits essentially serve the same purpose – the banks have an incentive for you to leave your money in the account so they can lend it, plus it helps ensure they remain in compliance with federal regulations regarding reserve requirements.
How to Avoid Paying Penalties for Early Withdrawal
The early withdrawal penalties are most prevalent on fixed-term savings products or high-yield savings accounts that are designed to be long-term investments. That’s also why these types of funds often have higher opening deposit requirements, and why they may be free for members as long as the balance doesn’t drop below a certain threshold.
Avoid opening accounts with penalties or balance requirements if you don’t think you can adhere to the balance requirements. It’s probably best not to put money you think you might need soon into a fixed-term savings account with a maturity date that’s several years away.
You can also open multiple accounts with different purposes. For example, checking accounts are designed for frequent transactions and don’t typically have penalties regarding early withdrawals (although they may have minimum balance requirements to avoid fees). You could have a checking account for everyday expenses and a savings account that you don’t withdraw from frequently, as well as one or more share certificates with funds you know you won’t need soon.
Utilizing several different accounts can help ensure you have liquid money when you need it while still earning a reliable yield on funds you might not need for several years or more.
Enjoy Great Banking Services Without High Fees or Penalties With OnPath Federal Credit Union
As a not-for-profit credit union, OnPath FCU doesn’t charge high penalties or fees to increase profits for investors. Our commitment to our members has tangible benefits that can be felt in all our products, such as lower fees and fewer penalties. Discover why so many New Orleans residents and workers trust OnPath FCU by calling us 800.749.6193 or becoming a member.