Shedding a certificate of deposit for a T-bill -- will it pay?

Should a reader who bought a $7,500 four-year certificate of deposit on April 1, 1978, cash it, pay the penalty for early withdrawal, and invest the remaining cash in a six-month T-bill certificate at 13 or 14 percent? This reader is retired, aged 72, with a need for as much income as possible, with minimum risk, to counter inflation.

Two possible answers are contradictory. If the CD has been left to compound interest daily since it was bought and the intention is to keep all interest and principal together until maturity, the reader would lose $192.76 if the cash remaining after paying the penalty is invested at an average 13 percent for 13 months. If the average rate is 14 percent for the same period, the loss is only

These figures are based on redeeming the four-year certificate after two years and 11 months (April 1, 1978, through Feb. 28, 1981) and reinvesting the remaining principal at an average 13- and 14-percent return for the remaining 13 months.

Three problems immediately suggest that these assumptions are not practical. First, a minimum of $10,000 is needed for a six-month T-bill CD. Other funds would be needed. Second, if the reader reinvests the cash in a six-month T-bill CD, the 13 or 14 percent rate may not be available at the outset. Even more doubt remains that either rate will be available six months later when the CD matures and must be reinvested. Third, an extra month is involved. If the withdrawn principal were invested in a money-market mutual fund, neither the $10 ,000 minimum nor the 13 months pose a problem. However, money-market mutual funds do not guarantee a specific rate and the yield actually varies from day to day.

The $192.76 and $84.74 losses, respectively, result from comparing the final redemption value of the $7,500 CD, plus compounded interest, with the net remaining principal plus interest after penalties and reinvestment at 13 and 14 percent.

The penalty was loss of three months' interest plus a reduction during the remaining time to a passbook rate of 5 1/4 percent. The total penalty amounted to $706.70.

A second answer assumes that the interest payable on the $7,500 was withdrawn regularly. There would be no penalty if the reader had taken only interest for income to live on, but the principal would have remained at $7,500. If the CD were cashed early, the full penalty of $706.70 would be taken from the principal , leaving $6,793.30 to be invested at 13 or 14 percent for income. If interest payable on the $7,500 four-year CD were figured on a monthly basis, it would pay at 13 percent compounded daily; the monthly interest would be $78.61.

Thus, on a current basis, switching would provide more spendable dollars now. On a total capital basis, the switch would create a loss of principal.

Although answers vary with each situation, a switch from a four-year CD with a longer time to maturity could yield a gain in principal and more current income, assum ing 13 or 14 percent interest.