CDs Are Among the Safest Investments for Your IRA

A Low Risk/Return Option

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Image by Theresa Chiechi © The Balance 2019 

A CD IRA is a combination of two things: A certificate of deposit (CD) and an individual retirement account (IRA). You can use the two of them together, or you can use either one of them separately. For example, you might open an IRA that doesn’t offer CDs as an investment, or you can open CDs in other types of accounts (that aren’t IRAs).

Certificates of Deposit

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. To earn the higher rate, you need to leave your money untouched in that account for a certain amount of time (such as 18 months or two years).

In exchange for that commitment, your bank pays a higher interest rate. But what if you need your money sooner? CDs often allow you to withdraw your funds before the term ends, but they typically charge an early withdrawal penalty for doing so. However, some CDs are liquid CDs, allowing you to pull some or all of your money out early without any penalty. Keep in mind that there might not be any penalty from the bank, but you might have to pay income taxes or various penalties to the IRS as a result of taking IRA distributions.

CDs are a straightforward investment: You pick a timeframe that you’re comfortable with, and you know exactly how much you’ll earn. You can also try advanced strategies like CD ladders to address changes in interest rates and the potential need for free cash.

You can buy CDs from almost any bank or credit union, and online banks typically offer some of the highest rates in the nation (often with no monthly fees).

Individual Retirement Accounts

IRAs are a type of account designed for retirement savings. They offer certain tax benefits (that come with tradeoffs, of course), which can hopefully help you accumulate savings for retirement:

  • Contributions might be tax-deductible (depending on your income and the type of IRA you use)
  • You may be able to shield interest earnings in the account from current taxes (or growth could even be tax-free, again, depending on the type of IRA you use)

There are two basic types of IRAs: Traditional and Roth.

Traditional IRAs: You have the opportunity to (potentially) deduct your contribution from your income—check with your tax preparer to find out if you can deduct. Later, in retirement, you typically have to pay income tax on those withdrawals.

Roth IRAs: Your contributions are not deductible. However, you have the opportunity to (potentially) withdraw your money without any further tax liability—assuming you follow all of the IRS rules and get approval from your tax preparer.

In exchange for offering potential tax benefits, there are also strings attached to IRAs. In some cases, if you pull your funds out early, you may have to pay additional tax penalties—and there may be other consequences, like failing to withhold sufficient taxes. Make sure you understand the rules or seek expert advice before you put money into an IRA or take a distribution.

Using CDs Inside of an IRA

An IRA is a type of account that allows you to use many different types of investments—CDs are just one option. Likewise, you can own CDs outside of your retirement accounts: You can own them individually, or jointly with a spouse, for example.

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.

Pros and Cons of CD IRAs

A CD IRA is a retirement account that you invest in CDs. So, when might you do that?

Conservative investors: It might make sense to use CDs if you’re a conservative investor who wants to make sure you don’t lose money in the stock markets. Assuming your bank (and 100 percent of your account balance) is FDIC insured, you receive a government guarantee that you won’t lose money in that account.

Better than a savings account? With your IRA invested in CDs, you can expect to earn slightly more than you’d get from a savings account. A higher interest rate always helps, but do some calculations to understand how your returns affect your retirement. Also, be aware that you may lock your money up at a given rate only to see rates rise higher. In those cases, a bump-up CD may alleviate some of your suffering.

Long-term investing: Any interest you earn is helpful, but it might not be enough to help you outpace inflation over the long term. Depending on your needs, goals, and ability to take risk, it might be worth looking at other types of investments. Speak with a financial planner to determine your needs, and seek help from a licensed professional if you need investment advice.

All or none? Using CDs (or not) in an IRA isn’t a black-or-white thing. You can own CDs and other types of investments. CDs may work well for your safe money, or as a cash bucket for near-term spending.

Important: Tax laws are complicated, and the rules change from time to time. Speak with a local competent tax advisor before you make any decisions about what to do (or not) with your money. This article is written with no knowledge of your circumstances, and it is general in nature, so it cannot be considered investment advice.