There is an interesting post over at My Money Blog about the Ally Bank 5-year Certificate of Deposit and how you can profit from it. If you have been looking into CDs you will have noticed that the longer the CD, the higher the rate offered. Ally’s 1-year CD currently pays 1.54% APY whereas the 5-year CD rate is 2.99% – almost double.

But what if you don’t want to lock in your money for the full five year period? Most banks, including Ally, will charge you an early withdrawal penalty if you pull your money out before the term of the CD is over. In Ally’s case they charge a penalty of the last 60 days of interest.

But with the dramatic difference in yields between the 1-year and 5-year CDs, you would actually come out ahead by only keeping your money in the 5-year CD and pulling it out after a year if you needed. If you factor in the withdrawal penalty you would still be making an annualized rate of 2.57% after one year in the 5-year CD. There is no bank that will pay you anything close to 2.57% for a one-year CD.

After 2 years your annualized rate, factoring in withdrawal penalties, is 2.83%, which still beats Ally’s current 2-year CD rate of 2.00% APY.

After 3 years your big yield advantage starts to drop off. You annualized rate for 3 years is 2.91%, which is an excellent rate although a few banks do offer 3-year CDs around that level.

Here is a chart from My Money Blog that shows the annualized rate of return with and without a withdrawal penalty:

Now one thing to watch out for with this strategy is whether Ally (or whichever bank you go with) changes their early withdrawal rules. If this changes to 180 days worth of interest then the advantages of breaking a 5-year CD term are probably gone.

One strategy for maximizing your savings would be to buy several CDs in smaller denominations. If you wanted to put $100,000 aside, for example, you could buy five $20,000 5-year CDs. If you needed to withdraw $20,000 you would only need to break one CD and would leave the other four intact. You would be maximizing your short-term yield while minimizing your withdrawal penalties.

The Bottom Line: If you’re looking for better short-term CD rates, put your money into a 5-year CD with small withdrawal penalties. If you need to pull your money out sooner than five years you’ll still be making a much better yield than a 1 or 2 year CD.