What Is a Roth IRA CD?

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DEFINITION
A Roth IRA CD is a certificate of deposit (CD) held within a Roth individual retirement account (IRA). By holding a CD within a Roth IRA, an investor might gain certain tax advantages.

A Roth IRA CD is a certificate of deposit (CD) held within a Roth individual retirement account (IRA). By holding a CD within a Roth IRA, an investor might gain certain tax advantages. 

Let’s take a closer look at what Roth IRA CDs involve.

Definition and Examples of a Roth IRA CD

A Roth IRA CD essentially combines a Roth IRA with a CD

A Roth IRA is a type of retirement account that allows individuals to contribute post-tax money, which can then grow tax-free and be withdrawn tax-free, assuming some conditions are met. A CD is a type of savings account that provides a predetermined interest rate in exchange for holding a given amount of money in that account for a certain period of time, which might be a few months or several years, depending on the CD.

So, a CD within a Roth IRA structure means that the account holder can receive interest from a CD within a Roth IRA, rather than within a regular CD account at a bank.

A Roth IRA CD differs from a traditional IRA CD, as those involve CDs within a traditional IRA account, which have different tax treatments. For example, funds withdrawn from a traditional IRA are taxable. 

By holding a CD within a Roth IRA, the interest you earn can eventually be withdrawn tax free. The difference between paying taxes on interest from a CD and earning tax-free interest within a Roth IRA might not seem like much, but it can add up.

For example, say you manage to save $1 million, which you might be able to achieve through a lifetime of saving and investing. Earning just 1% interest per year on that $1 million would result in $10,000 of interest earned. If you paid taxes at an effective rate of 20%, you would be taxed $2,000 on that $10,000 of interest income. 

But with a Roth IRA CD, that full $10,000 in interest could be withdrawn tax-free in retirement if you’re at least 59 ½ and meet the five-year holding rule for Roth IRAs. So, in this scenario, a Roth IRA CD could save you $2,000 in taxes per year compared with taxable interest on a CD held outside of a Roth IRA.

How a Roth IRA CD Works

Before you can purchase a Roth IRA CD you must first qualify for a Roth IRA account. If you earn too much money—$144,000 or more as a single filer, or $214,000 or more if married filing jointly for 2022—then you can’t make any contributions to a Roth IRA account. If you are eligible, you can open a Roth IRA CD with a financial institution that offers these accounts. 

In some cases, you might be able to access CDs through your current Roth IRA provider, but in others you may have to roll funds from one Roth IRA provider into another that offers Roth IRA CDs. From there, you can deposit funds with the Roth IRA CD provider and choose the type of CD you want to open. 

Generally, the longer the term of the CD, the higher the interest rate it will pay. But committing to, say, a five-year Roth IRA CD instead of a one-year Roth IRA CD means that your money is locked up for longer. If you want to withdraw funds before the CD matures, you often have to pay a penalty that negates some of the interest earned. You might, however, be able to at least withdraw the interest you earn from the CD without paying a penalty, as long as you keep the principal invested. And you still may have to keep tax implications in mind.

What a Roth IRA CD Means for Individuals

Roth IRA CDs might be attractive to some individuals, such as if you’re nearing retirement or are already retired and want to earn some interest without taking on too much risk. If you invested in other assets within your Roth IRA, such as stocks, then your principal might be at risk. But you can protect your principal by investing in CDs, including Roth IRA CDs, at financial institutions that are FDIC insured.

Still, there are risks to keep in mind with Roth IRA CDs. For one, you might not earn much on your principal compared to other investment opportunities, and you might not have as much liquidity as you’d like. One way to overcome this risk, however, is to use strategies like building CD ladders, where you invest in CDs of varying lengths. 

Given the many investment considerations and tax implications with Roth IRA CDs, you may also want to speak with a professional to weigh your options.

Key Takeaways

  • A Roth IRA CD allows individuals to invest in a CD within a Roth IRA structure.
  • Roth IRA CDs can help individuals gain retirement income in a tax-advantaged way.
  • To open a Roth IRA CD, you must still meet the regular eligibility requirements for Roth IRAs.

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Article Sources

  1. Internal Revenue Service. “Traditional and Roth IRAs.”

  2. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”