Sunday, March 18, 2012

INOVA 6-Year CD

Update: INOVA has slashed its rates, so their 5-year and 6-year CDs no longer are competitive with the PenFed CU 5-year and 7-year CDs. There is no longer a reason to read this post other than for some general background on why to consider CDs; e.g., the Why I Am Doing This section.

I’ve run across another CD I like: the INOVA Credit Union 6-Year CD. It pays about 2.50% APY, and the early withdrawal penalty (EWP) is only six months of interest. I am transferring funds currently held in IRA money market accounts (paying almost no interest) at Vanguard and Fidelity into IRA CDs at INOVA CU. Following are more details on the features of the CD, comparison to other CDs I like, an explanation of why I am doing this, and a description of my experiences in opening the account and transferring the money into the CDs at INOVA. This is a long post, but hopefully you’ll appreciate the details.

Features

The current APY (Annual Percentage Yield) for the standard 6-year CD currently is 2.50% in a taxable account (individual, joint, trust, etc.) and 2.60% in an IRA account.

Alternately, they offer a “Step Up” CD that pays 10 basis points less (2.40% in taxable and 2.50% in IRA). Here is the way INOVA describes the step up CD:

This flexible savings program allows you to change your certificate rate one time during the term. If the rates go up - you're covered! You can "step up" to the higher rate!”
So, for example, if the rate on their 6-year CD increases to 3.50% in two years, you can choose to increase your rate by 1%. Note that you can only do this once during the 6-year term of the CD. This is a really nice feature, since it gives you some protection against rising interest rates without having to do an early withdrawal and pay the EWP. I chose the step up CD.

The EWP (Early Withdrawal Penalty) is only six months of interest (180 days to be precise). So, for example, if you withdraw your money after one year, you’d earn about half of the stated APY, or 1.25%. Here is the early withdrawal statement from the INVOA disclosures (the parts in bold are applicable to the 6-year CD):

Early Withdrawal Provisions. We will impose a penalty if You withdraw any of the principal funds from Your Account before the maturity date. The penalty imposed will equal 30 days of dividends on Your Account for Accounts with a term that is less than 90 days, 90 days of dividends for Accounts with a term from 90 days to one year and 180 days of dividends for Accounts with a term greater than one year.
The INOVA branch rep has told me that you can do partial early withdrawals from a CD. For example, if you have a $10,000 CD and you want to take an early withdrawal of $1,000, you can withdraw $1,000 and only pay the EWP on $1,000. Note: I do not see this in the Terms and Conditions document, and have sent an email asking about this.

As with any CD I would consider, it is federally insured up to at least $250,000. Here is the relevant statement from their website:

Your combined savings (share savings, checking and certificate deposits) are federally insured to at least $250,000 through the National Credit Union Share Insurance Fund (NCUSIF) and backed by the full faith and credit of the United States Government. Your IRA is insured for an additional $250,000 through the NCUSIF.

For example, is you could have a $250,000 CD in an individual or joint account, and another $250,000 CD in an IRA account, and be fully insured. Of course you would want to stay enough under these limits so that you won’t exceed them after interest accrues over the 6-year term. This is no different than any other federally insured CD.

Comparison with Other CDs

The 2.50% APY of the INOVA 6-year step up CD with an early withdrawal penalty (EWP) of six months of interest is very competitive. Here are the current rates (APY) and EWPs for the other CDs I like:

  • PenFed 7-year: 2.50%, EWP = one year of interest
  • PenFed 5-year: 2.00%, EWP = one year of interest
  • Ally Bank 5-year: 1.74%, EWP = 60 days of interest

The INOVA 6-year CD currently is about the best CD for any term up to six years unless you do an early withdrawal in less than about 1.5 years. If you withdraw your money before about 1.5 years, you come out ahead with the Ally 5-year CD. Otherwise, you win with the INOVA 6-year CD.

So, the Ally CD still is a good deal if you expect interest rates to rise much within 1.5 years, or for other reasons think you might want to withdraw your money early. This assumes of course that Ally honors it’s current early withdrawal terms.

To read more about comparing CDs assuming early withdrawals, read Comparing Top Long-Term CD Rates After Early Withdrawal Penalties at the excellent website http://www.depositaccounts.com/. This is the primary site I use to stay up to date on CDs, reward checking accounts, and online savings accounts.

The one-time step-up option gives the INOVA CD another edge over the other CDs, since it allows you to increase your rate one time without doing an early withdrawal and paying the EWP. For me, this pushes it to the top of the pack.

Note that Ally Bank also has “raise your rate” CDs (2-year and 4-year terms) that are similar to the INOVA step-up CDs. Although you may be better off paying the low EWP on the Ally 5-year CD and reinvesting at a higher rate, the “raise your rate” CDs are a good choice if you’re nervous about doing early withdrawals.

Considering all of the above, the INOVA 6-year CD is my top choice for a CD, unless you think it’s quite likely that you’ll withdraw your money in less than 1.5 years, in which case the Ally 5-year CD is a better bet.

If you are a relatively high net-worth investor with a large fixed-income allocation in IRA accounts, you might consider opening up IRA CDs at each of the institutions mentioned here, up to the maximum federal insurance limits. Factor in the interest you’ll earn over the term of the CD when determining the insured amount; i.e., you want the value at maturity, after earning interest over the term, to be $250,000 or less at each bank or credit union.

Why I Am Doing This

It would have been easier just to leave my money in the IRAs at Vanguard and Fidelity, and invest in one or more bond funds. Here are the main reasons I am going through the hassle of transferring into CDs at INOVA CU (and before that at Ally Bank and PenFed CU):

  • The interest rate on the CD is much higher than a comparable bond fund.
  • There is no risk of decline in value of the CD if interest rates rise.
  • If rates rise enough, I can use the one-time step up option to increase my rate (INOVA only), and if rates rise more, I can do an early withdrawal, pay the EWP and reinvest at a higher rate.
Since the CD is federally insured, a comparable bond fund is one that has no credit risk (risk of default on payments of interest or principal). An example of such a fund is the Vanguard Intermediate-Term Treasury fund (VFITX). The current SEC Yield on VFITX is 0.83% (if investing over $50K, you can buy the Admiral Share class and get 0.93%). So the CD yields about 3 times more than the bond fund.

Even if you are willing to accept some credit risk, and invest in something like the popular Vanguard Total Bond Market Index fund, the SEC yield is only 2.05% (2.17% for Admiral Shares, $10K minimum), still lower than the federally insured CD which has no credit risk.

The duration of VFITX (the treasury bond fund) is 5.2 years, which means that if interest rates rise 1%, the value of the bond fund will fall about 5%. If interest rates rise 2%, the value will fall by about 10%, and so on. By contrast, if interest rates rise by any amount, the value of the CD will not fall at all.

The one-time step up option allows me to simply increase my rate one time to the higher rate. If rates rise further and I pay the EWP to do an early withdrawal, my loss is limited to half of one year’s interest, so about half of the APY of 2.50% = 1.25%. The maximum loss on the CD in doing an early withdrawal is 1.25% vs. a potential loss on a bond fund of 5%, 10% or more, depending on how much rates increase.

Keep in mind that a bond fund will eventually recover the loss because of the higher rate, so it’s not something to worry a lot about in the long term, but you will come out ahead with the CD because of the limited downside of 1.25% in doing an early withdrawal to reinvest at the higher rate.

Some people are worried that the bank or credit union will change the terms of the CD, and either increase the EWP or simply not allow early withdrawals. Two credit unions actually have increased the EWP on existing CDs over the last year, but in each case depositors were given the option to withdraw their money and pay the original EWP before the change went into affect. Some depositors were even allowed to withdraw their funds from the CD with no EWP (they complained enough).

(PenFed increased the EWP on their 5-year CD from six months of interest to one year of interest, but the change only applied to new CDs, so the 5-year CD I bought at PenFed in late 2010 still has the six months of interest EWP.)

I did some analysis to evaluate the risk of being disallowed to do an early withdrawal. I compared the return of a 5-year CD (held to maturity) to a comparable bond fund (held for five years). In most scenarios I looked at the CD still came out ahead. This increased my confidence in preferring CDs to bond funds. If you really want to torture yourself, you can read about the analysis I did in my post CD vs. Bond Fund: what if no early withdrawal? on the Bogleheads Investment Forum, along with a lengthy discussion about it with other Bogleheads.

Despite my preference for selected CDs in the current environment, they are not as liquid as bond funds, money market funds, or deposit accounts (savings and checking). So I still keep about 50% of my fixed income (bonds, CDs, cash) in bond funds, and a good chunk in high-yield savings accounts and reward checking accounts. This provides liquidity for short-term spending needs, as well as a highly liquid source of funds for rebalancing into stocks when stocks decline significantly in value.

I know the bond funds will decline in value when interest rates rise, but the CDs will significantly soften the blow on the overall fixed-income portion of my portfolio. I’ll also have the option of rebalancing from CDs back into bond funds if bond fund rates become more competitive with CDs.

The Account Application and Transfer Process

Summary

In summary, the process of becoming a member of INOVA credit union has been a bit more cumbersome and time consuming than my experiences with Ally Bank or PenFed Credit Union, but the process of transferring the money from Vanguard and Fidelity to INOVA has been easy and quick. There has been more application paperwork than usual, and some disconnects between the online application and the paperwork that followed. However, for me it has been worth it due to the great features of the CDs. Also, the service I have received from the branch representative, Rebecca, has been outstanding. Following are details of my experience to date.

Getting Started

I first called the 800 number listed on the INOVA website to ask some questions. The representative was not able to answer any of my questions. She put me on hold to get some answers, but I was disconnected. I had left my phone number in case I was disconnected, but did not receive a call back. Don’t bother calling the 800 number, except perhaps to get the phone number of the branch closest to you.

The next day I looked up the phone number of the closest branch, which happens to be in Berkeley (CA), called, and left a message. I got a call back within the hour, and the representative, Rebecca, was very knowledgeable and helpful. She was able to answer all of my questions, and explained what I had to do to get started.

One of my questions was if they would guarantee the interest rate during the process of transferring the money from my other IRA accounts. I didn’t want to transfer a large sum, only to have the rate drop significantly before the transfer was completed (I have seen this happen to someone else at PenFed). Rebecca told me that they would do so. I was pleasantly surprised, and consider this a big plus.

Opening the Account

Rebecca told me to start by filling out the online application on the INOVA website, but that she would be handling the process directly with me after that. Here is a direct link to the application. If you’re reading this in email and the link doesn’t work, just go to http://www.inovafcu.org/ and click Join Today! at the top right of the web page.

As with all credit unions, you have to become a member. It is unlikely that you will meet one of the standard membership requirements (e.g., being an employee of a certain company), but you can qualify for membership by paying a one-time fee of $10 to join a non-profit organization. As of now the application says: “You may elect to join Tru Direction which is a not for profit organization.” I thought Rebecca said there also was a $10 membership fee, but so far I’ve only been charged a single $10 fee, so I’m not sure if I misunderstood, and there is only the $10 fee to join the non-profit organization.

You also must deposit a minimum of $5 to a savings account. You can fund the savings account deposit with a credit card, which is nice if you have a cash-back credit card. The online application said you could deposit up to $500, but I was only able to deposit $450 (I tried $500, then $499, but each time received a message saying this exceeded the limit, so then tried $450 and it worked). Since I get 2% cash back on my credit card, I earned $9.00 on the $450 deposit, almost paying for the membership fee (or whatever the $10 fee was for). At some point I will just withdraw all of this except for the $5 one must keep in the savings account.

Shortly after completing the online application, Rebecca emailed me the paper application, and called to let me know she had done so. I filled it out, printed it, scanned it, and emailed it back. I also scanned my driver’s license and emailed that with the application.

Unfortunately, this is not all you have to do. You also have to get the application notarized, and mail it to INOVA. This is unusual, in my experience, and kind of a hassle, but again, it was worth it to me to get this great CD deal. I had the application notarized and mailed it to Rebecca the next business day (the only reason I emailed a copy back first was to get the next set of forms more quickly).

There is some redundancy and confusion between the online application and the paper application. For example, you enter in answers to five security questions in doing the online application, and then you must enter in answers to seven more security questions on the paper application (some of the questions end up being the same). By security questions, I mean things like “what is your Mother’s maiden name”. Another example is that you select a user name and password when doing the online application, but this doesn’t work to login once your account is opened. After the account is opened, you are assigned a user ID and temporary password that you use to log on to the website.

Another glitch is that after the account was opened, I was unable to log on to the website using Google Chrome, which is the browser I use for almost everything. I was able to log on using Internet Explorer. Hopefully they will fix this bug.

Transferring the Money from Existing IRAs to INOVA

In summary, the process of transferring the money from my existing IRA accounts into the new INOVA account was standard, straightforward, and relatively fast. Rebecca monitored and expedited the process at every step.

The next forms I had to fill out were a one-page IRA application form and the one-page forms authorizing the transfers from my Vanguard and Fidelity IRA accounts. This is standard; it is exactly the way it worked with Ally and PenFed. I filled out the forms and mailed them to Rebecca.

Four days after I mailed the transfer authorization forms to INOVA, the funds were distributed from my Vanguard IRA Account; that’s fast! I should mention that Rebecca had emailed me asking about overnight mailing addresses for Vanguard and Fidelity, which I supplied her (I simply looked them up on their websites). This is an example of the diligence Rebecca has been demonstrating at every step of the process.

After receiving the funds from Vanguard, Rebecca emailed me another two forms that I had to sign (they were already filled out), scan, and email back (you can simply mail them, but I like to cut out the extra snail mail time). Four business days later, the CD was opened at INOVA; so a total of eight business days elapsed from mailing the transfer forms to INOVA to having the first CD funded. One down, one to go!

It was seven business days after I mailed the transfer authorization forms to INOVA until the funds were distributed from my Fidelity IRA account—a little slower than Vanguard for some reason, but consistent with my previous experiences in doing IRA transfers from Fidelity to Ally Bank. As I write this, it is 9 business days since I mailed the forms, and INOVA has not yet received the funds from Fidelity. In my previous transfers from Fidelity to Ally, between 11 and 14 business days elapsed between mailing the form and funding the CD. When INOVA receives the funds, Rebecca will send me the two additional forms to sign and email back, and the second CD will be funded.

3 comments:

Mat said...

Great writeup. Within the past few weeks, I've done the same in setting up an INOVA account and opening a 6 yr step-up CD. The requirement of a notarized paperwork was a bit of a pain. BTW, it looks like their CD rates have since dropped by 0.50% (now 2.00% for the 6-yr step-up). Glad I got in before this rate drop.

I didn't realize at the time that INOVA also offers a rewards checking with 3.00% APY on balances up to 20k (with certain catches, i.e., direct deposit, 15 credit card transactions per month, etc.), so I opened one of these as well (and had more notarized paperwork to send them). I'm pretty pleased that, at least for the time being, I have two of among the highest-yielding CD and reward checking accounts all at the same institution.

One minor drawback so far is that it doesn't seem that INOVA allows for external transfers, which I'd become accustomed to from online banks like Capitol One, TIAA-CREF), but that's not the biggest deal. If I need the money, I can just write myself a check.

Kevin said...

Thanks for comments Mat.

I recently published a short post on the lower rates.

The INOVA RCA just changed I guess. I was seeing 4.01% on up to $10K on depositaccounts.com, but now see it's changed.

You can set up ACH transfers to/from INOVA from another bank that supports them, e.g., Ally Bank. That's what I do with my RCAs, which typically do not support setting up ACH links on their end.

Kevin

Ryan said...

Kevin -

When you funded the account with a credit card, did it register as a cash advance or a purchase transaction? And what bank is your CC issuer?

Thanks!

Ryan