| It
can sometimes be difficult to handle depositor questions
about early withdrawal penalties. Are penalties always
required? Can they be negotiated? When can they be waived?
This article will attempt to answer those questions
and more.
Time Deposits
Generally
The law surrounding early withdrawal penalties affects
accounts referred to as “time deposits.”
Regulation D defines the term “time deposit”
to include certificates of deposit and share certificates
(CDs). An early withdrawal penalty is usually imposed
when a depositor makes a withdrawal from a CD prior
to the maturity date set forth on the certificate.
There are several laws which impact the issue of early
withdrawal penalties. These include Reg D, Truth in
Savings, and general contract principles which are generally
summarized on your account agreements.
Early
withdrawal penalties
Federal law requires that all CDs be subject to a minimum
penalty upon early withdrawal. The minimum penalty required
under Regulation D is seven days’ simple interest
on the amount withdrawn during the first six days of
deposit. Technically, after six days have elapsed without
a withdrawal, there is no legal requirement that a penalty
be imposed. [12
CFR 204.2(c)(1)]
If your institution allows for partial withdrawals,
Reg D has an additional penalty provision. For partial
withdrawals, the law states that a penalty of at least
seven days’ simple interest on amounts withdrawn
within six days after each partial withdrawal must be
imposed. For deposits made in one lump sum, Reg D regards
a partial withdrawal from the account as a withdrawal
of the entire deposit followed by a new deposit of the
balance retained. This second penalty is confusing but
basically is just a restatement of the first penalty.
It is intended to clarify that the penalty must be imposed
during the six day time period following the “redeposit”
of the balance remaining after the partial withdrawal.
Keep in mind that the law does not restrict your ability
to contract for penalties greater than those imposed
by Reg D. Many institutions contract for penalties much
greater than those stated in Reg D and this is perfectly
acceptable. While Reg D specifies a minimum penalty,
there are no restrictions on the maximum early withdrawal
penalty you can impose.
EXAMPLE
Mr. Porter opened a 5-year CD and was told that
there would be a 3-month penalty upon early withdrawal.
He was surprised, and tried to negotiate a lower penalty
at account opening. Could the penalty be reduced for
Mr. Porter?
Technically, yes as Reg D only requires is a penalty
of 7 days simple interest. However, before the penalty
is reduced, it would be important to understand what
bank policy is on this issue and how to reflect any
changes to the certificate and account opening disclosures.
Penalties
must be disclosed
In order to impose your early withdrawal penalties,
they must be contracted for and disclosed under Truth
in Savings. In making your disclosure, Truth in Savings
requires that the following items be included in the
account disclosure:
-
A statement that a penalty will or may be imposed
for early withdrawal;
- An
explanation of how the penalty is calculated; and
- The
conditions for assessing the penalty.
Disclosures provided to the depositor at the time of
account opening are generally considered part of the
contractual relationship with the depositor
Waiving
the minimum penalty
There are some circumstances where Reg D will permit
you to waive the minimum early withdrawal penalty.
These circumstances include:
-
Where the time deposit is part of an IRA, Keogh (H.R.
10) plan or in a 401(k) plan and the early withdrawal
occurs within seven days after establishment of the
IRA or other plan. However, the depositor must forfeit
an amount at least equal to the simple interest earned
on the amount withdrawn.
- When
the time deposit is part of an IRA, Keogh plan or
a 401(k) plan and the depositor reaches age 59 1/2
or is disabled.
- When
the depositor withdraws a portion of the time deposit
which is not insured by federal deposit insurance
because of the merger of two institutions where the
depositor held separate time deposits. This exception
lasts only for one year after the merger.
- Upon
the death of any owner of the time deposit.
- When
the owner of the time deposit is judicially declared
to be incompetent.
- Where
the time deposit is withdrawn within ten days after
a specified maturity date even though the deposit
contract provided for automatic renewal at the maturity
date.
Beyond these exceptions, the law does not permit a waiver
of the minimum penalty.
Example
Susan wanted to cash in the CD she opened 3 days
earlier. She was surprised when an early withdrawal
penalty was imposed. Susan was sure she had at least
3 days to change her mind and remove the funds without
penalty. Can the penalty be waived?
No. The penalty MUST be imposed. Unless one of
the statutory exceptions apply there is no way around
the penalty. Because Susan has not held the funds
for at least 6 days, the penalty is legally required.
Unfortunately for Susan, there is no such thing as
a 3-day waiting period under Reg D.
Waiving
penalties greater than the minimum
It is possible to waive penalties you have contracted
for are greater than those specified in Reg D. In doing
so, it is important for you to be aware of your own
bank policy as well as general principles of contract
law.
-
Consider your deposit contract. From a contractual
standpoint, your financial institution should probably
enforce the early withdrawal penalty contracted for
with the depositor. This avoids any misunderstandings
between you and your depositors and it keeps examiners
from questioning why you are not adhering to contractual
terms and conditions. Also, if you choose to waive
a penalty that is in excess of the required minimum
penalty, consider the impact such a waiver may have
on the enforceability of the remainder of the deposit
contract.
- Consider
your customer.
What are the implications of waiving a penalty for
one customer and not another? There may be discrimination
and customer service types of issues that should be
considered by your management.
- Follow
your policy. Before waiving a penalty that is
in excess of the required penalty, review your internal
policy regarding waiver of the early-withdrawal penalty.
If you don’t have a policy, consider developing
one. The policy should be in writing and tied to reasonable
criteria that are not discriminatory in nature.
EXAMPLE
Hagen Construction had all their business accounts
at your bank, and needs some cash for a loan transaction.
Today Mrs. Hagen decided to cash in a corporate
CD that had been open for several years. Upon hearing
about the early withdrawal penalty Mrs. Hagen stated
that her company may need to “take its business
elsewhere.” Can the penalty be waived?
Yes, if bank policy permits. The technical legal
limits of a minimum penalty have passed and so this
is a matter of bank policy. A waiver may be appropriate
since this is an established depositor who needs
the funds in connection with a loan transaction.
Conclusion
Over
the years, the penalty provisions of Reg D have been
simplified and streamlined. While there is still a minimum
penalty that must be imposed, ultimately early withdrawal
penalties are a contractual and bank policy matter.
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