What Is an IRA CD?

Definition & Examples of IRA CD

Image shows a pros cons list. Text reads: "Pros and cons of CD IRAs: Pros: It's a safe bet for conservative investors–there's usually a government guarantee. It's ideal for safe money or near-term spending. Cons: you only earn slightly more than you'd get from a savings account. It's not ideal or long-term investing"

Image by Theresa Chiechi © The Balance 2019 

An IRA CD is a combination of an individual retirement account (IRA) and a certificate of deposit (CD).

What Is an IRA CD?

An IRA is a type of account that allows you to use many different types of investments. Certificates of deposit (CDs) are one option. You can own certificates of deposit outside of your retirement accounts as well.

Depending on where you have your IRA, CDs might or might not be an option. For example, some brokerage accounts don’t offer CDs. Conversely, CDs might be the only option if you open your IRA with a bank or credit union.

IRA CDs vs. CDs
IRA CDs CDs
Are purchased within an IRA  Are purchased outside an IRA 
Interest earned is tax-free  Interest earned is taxable upon redemption

How IRA CDS Work

Using CDs as part of your retirement savings isn’t a black-or-white choice. You can own certificates of deposit along with other types of investments. Depending on your financial situation, how comfortable you are with risk, and how close you are to retirement, CDs may work well for your retirement savings or as a cash bucket for the near future.

A certificate of deposit (CD) and an individual retirement account (IRA) are two different things. For example, you might open an IRA that doesn’t offer CDs as an investment, or you can hold certificates of deposit that aren’t part of your retirement accounts.

CDs are safe investments when purchased through federally-insured banks and credit unions. They pay interest on your cash, and they often pay more than you can earn in a standard savings account.

When you open a CD, you commit to leaving your money untouched in that account for a certain amount of time, such as 18 months, two years, five years, or more. In exchange for that commitment, your bank pays a higher interest rate.

You can often withdraw your funds from a CD before the term ends, known as the maturity date, but you will typically be charged an early withdrawal penalty for doing so. However, some CDs are liquid CDs, allowing you to pull out some or all of your money early without any penalty. If you hold the CD in an IRA, this would not apply.

If you withdraw funds from an IRA CD before the CD's maturity date, there might not be any penalty from the bank. However, you might have to pay income taxes or various penalties to the IRS as a result of taking IRA distributions.

Types of IRA CDs

The type of tax benefit you get from your IRA CD depends on whether you have a Traditional or Roth IRA.

Traditional IRA

Contributions are deductible from your taxable income. Later, in retirement, you typically have to pay income tax on your withdrawals.

Roth IRA

Your contributions are not deductible. However, you can usually withdraw your money without any further tax liability when you take distributions during retirement.

Pros and Cons of CD IRAs

A CD IRA is a retirement account that you invest in CDs. Like any investing choice, it has both advantages and drawbacks.

Pros

Government-Protected Investment

If you’re a conservative investor who wants to avoid the stock market, investing in an IRA CD from a bank is a good way to protect your money. Banks are FDIC insured, so you receive a government guarantee that you won’t lose money in that account.

Guaranteed Returns

With your IRA invested in CDs, you get guaranteed returns at a higher rate than you’d get from a savings account. This is good for investors who are later in their careers or closer to retirement.

Cons

Locked Into an Interest Rate

You may lock your money in a CD at a given rate only to see rates rise higher. In those cases, a bump-up CD can allow you to request a higher rate.

Better Long-Term Investment Options Available

Any interest you earn is helpful, but it might not be enough to help you outpace inflation over the long term. If you are still far away from retirement and able to take more risks, other types of investments may offer higher potential returns.

Some long-term, high-yield CDs have a call feature, which means that the issuing bank can choose to terminate, or "call," the CD after some specified period of time. The call date of a CD is different than its maturity date.

No matter which type of IRA you have, you will usually pay tax penalties if you withdraw funds before retirement. You may also have to pay additional tax on distributions if you failed to withhold sufficient taxes earlier.

Key Takeaways

  • IRA CDs are certificates of deposit invested in an individual retirement account.
  • These CDs are a conservative investment with guaranteed returns.
  • IRA CDs are better suited to investments made closer to retirement.
  • They can be mixed with other types of IRA investments.
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Article Sources

  1. Investor.gov. "Certificates of Deposit (CDs)." Accessed Oct. 10, 2020.

  2. Consumer Financial Protection Bureau. "What Is a Certificate of Deposit (CD)?" Accessed Oct.10, 2020.

  3. Internal Revenue Service. "Traditional and Roth IRAs." Accessed Oct. 10, 2020.

  4. Ally Bank. "IRA High Yield Certificate of Deposit (CD)." Accessed Oct. 10, 2020.

  5. Discover. "IRA Certificate of Deposit." Accessed Oct. 10, 2020.

  6. Securities and Exchange Commission. "High-Yield CDs: Protect Your Money by Checking the Fine Print." Accessed Oct. 10, 2020.

  7. Internal Revenue Service. "Publication 590-B (2019), Distributions from Individual Retirement Arrangements (IRAs): When Can You Withdraw or Use Assets?" Accessed Oct. 10, 2020.