What Is a Pre-Encashable Deposit?

A pre-encashable deposit is a feature of savings vehicles available in the U.S. and Canada, including term deposits and CDs, that offers the flexibility of penalty-free withdrawals to the account holder under certain conditions. A pre-encashable deposit may be a good choice for individuals looking for liquidity while saving in a guaranteed account.

Key Takeaways

  • Pre-encashable deposits, such as term deposits and certificates of deposits (CDs), allow penalty-free withdrawals to account holders under certain conditions.
  • Pre-encashable deposits in the U.S. can be made in vehicles that are considered low risk, in terms of price fluctuation, and that come with FDIC protection.
  • They offer a low interest rate in exchange for the right to withdraw flexibility from pre-encashable accounts.

Understanding Pre-Encashable Deposits

Pre-encashable deposits are available in a wide range of investment vehicles, including term deposits and certificates of deposit (CDs), both of which can be held in tax-deferred accounts. Guaranteed investment certificates, which typically require longer holding periods, are less likely to include pre-encashable features. Although pre-encashables usually advertise withdrawals without penalty, most deposits require a certain minimum investment period before funds can be withdrawn without penalty to the principal.

Deposit instruments are a popular vehicle to manage cash or assets where the primary objective is protection of principal. Pre-encashable deposits in the U.S. can be made in vehicles that are considered low risk, in terms of price fluctuation, and that come with FDIC protection, meaning deposits up to $250,000 are insured by the Federal Insurance Deposit Corporation in the case of a bank failure.

Ready access to principal is another key feature that individuals may require when opening a savings or similar deposit account and one that makes pre-encashables an attractive option. Comparative alternatives like CDs assess early withdrawal penalties that, in the current low interest rate environment, can potentially wipe out any earned interest income. Money market accounts, meanwhile, have daily liquidity but tend to require higher minimum deposits and may have restrictions on the number of withdrawals in a given period. Some money market accounts, such as those offered by mutual fund companies, do not carry FDIC protection.

Why Pre-Encashable Deposits Offer Lower Rates

Generally, the longer a saver is willing to deposit their principal, the better rate a bank will offer. Banks and other savings institutions like credit unions do not offer pre-encashable deposit products per se, but they do include them as a feature of various deposit vehicles available. Savers will generally earn a lower interest rate for the right to the withdrawal flexibility from pre-encashable accounts, compared to accounts where principal remains in the account for a contracted period.

Banks would prefer to hold cash as long as possible, as it provides a base to make loans. Lenders can also earn net interest margins by paying 1%, for example, on a $10,000 deposit in a one-year CD and then lending out that same amount at 1.75%. The lender earns the difference of $75 as income.