What is an IRA CD?
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IRA CDs can be a great way to diversify your retirement portfolio. They can also help you earn a competitive fixed yield shortly before or during retirement.
What is an IRA CD and how does it work?
An IRA is an individual retirement account that can be invested in different assets, such as stocks, bonds and mutual funds. An IRA invested in certificates of deposit is called an IRA CD. Generally, IRA CDs earn a fixed APY. But some banks might offer a variable IRA CD APY.
You can open IRA CDs at banks, credit unions and brokerage firms. There are two options for IRAs: a traditional IRA or a Roth IRA. The key difference between these two IRA accounts is when they are taxed.
Traditional IRA contributions may be tax-deductible, according to the IRS. And those contributions are taxed when you withdraw the money. Roth IRA contributions cannot be deducted from your annual income, but they are not taxed when you withdraw the funds.
You should consult a tax adviser about the implications of these two options for your finances before making a choice.
CD vs. IRA CD
There are a couple of major differences between an IRA CD and a regular CD.
How much you can invest: With a regular CD, you can generally deposit as much as you want when you open the account. (Your bank might have limits. And you’ll want to be within FDIC limits and guidelines.) But IRA CDs have contribution limits. If you are under age 50 and earn taxable compensation, you could contribute up to $6,000 in 2022. Individuals 50 or over could contribute up to $7,000. For the 2023 tax year, you can contribute $6,500, or $7,500 if you’re 50 or over.
Withdrawal penalties: Most CDs come with early withdrawal penalties. Your financial institution will take a chunk of the interest you earned, if not all of it, if you withdraw the money before the term is up.
But with an IRA CD, early withdrawal might pinch you twice: Not only will your bank penalize you, but so will the IRS. There are tax implications, including a 10 percent penalty on retirement funds drawn before you are 59½ years old.
Which type of CD is better?
IRA CDs are best suited for savers who are retired or close to retirement because they are very low risk.
“A person at that point of their investment career needs to focus on stability and preservation of the capital they have built up,” says Elliot Pepper, CPA, CFP, co-founder of Maryland-based Northbrook Financial. “A CD, by its very definition, is designed to promote that. It also provides a steady, reliable and known stream of income.”
IRA CDs are not really a good fit for younger workers because they will not deliver the returns investors can get over time by putting money into higher-yielding assets like stocks, bonds and mutual funds.
“The primary variable I think about is time,” says Pepper. “A young person has time, whereas someone close to retirement doesn’t.
“An IRA CD is less volatile and returns are lower over time — lower than stocks. Therefore, I don’t think a younger person should be in an IRA CD,” he added.
A traditional CD can offer higher earning potential than a savings account, if you’re not close to retirement but still want a safe, fixed-rate investment for your money. Just make sure you won’t need this money during the CD’s term; otherwise, you’ll probably have to pay an early withdrawal penalty.
The best regular one-year CDs are yielding more than 5 percent APY.
It might be smart to consider other types of CDs, too. Some banks and brokerages offer a number of different types of CDs that pay decent yields and have more flexibility than traditional CDs.
For example, Synchrony Bank offers IRA no-penalty CDs that offer respectable APYs without the worry of having to pay penalty fees if you decide to withdraw your funds early.
Bump-up CDs might be worth a look, too, since the Federal Reserve is expected to raise rates at least one more time in 2023 to fight inflation. But the Fed’s future rate decisions in 2023 are uncertain, so a pause on raising rates — and even cutting rates — are also possibilities.
Pros and cons of IRA CDs
Anytime you’re considering investing your money in something, you need to weigh the potential benefits and drawbacks. Here’s a look at the main pros and cons of opening an IRA CD.
- Returns are guaranteed on fixed-rate CDs. Investing can be scary because the market fluctuates. But CDs are generally fixed-rate investments, so you can be certain in advance of exactly how much you will earn. But variable CDs do exist.
- The recent Federal Reserve rate hikes make borrowing money more costly but result in higher yields for savers at competitive banks.
- Funds are federally insured at an FDIC-insured bank or a National Credit Union Administration credit union. CDs taken out at federally insured banks and credit unions are protected up to $250,000 per depositor, per insured bank or credit union, for each account ownership category. Certain retirement accounts, single accounts and joint accounts are three examples of ownership categories.
- An IRA CD is a do-it-yourself retirement savings tool that does not carry the fees that come with trading stocks and having someone manage your portfolio. (An early withdrawal penalty or withdrawals if you’re under 59½ are potential ways you can incur a fee or an additional tax penalty.)
- You can pick your term. IRA CDs are typically available in terms as short as three months or as long as 10 years, giving you lots of options.
- You can build a CD ladder. A CD ladder is a savings strategy where you invest in several certificates with varying maturities. The short-term CDs make cash available in the near term while you take advantage of higher yields on longer-term CDs.
- Earning potential is limited. Even though CD rates are rising, you won’t see the kind of growth you can get over time by taking on more risk and investing in the market.“There is a trade-off in the safety and security of a CD investment and the ability to earn a potentially higher return in other investments that might be more risky,” Pepper says.
- Your money is locked up. If you’re stuck in a long-term IRA CD at a low rate, you’re missing out on opportunities for better earnings.
- Early withdrawal penalties. If you pull your money out of the IRA CD before the term is up, you will pay an early withdrawal penalty, which could eat up your gains. And if you’re not at least 59½ years old, you’ll likely have to pay a 10 percent penalty.
- Growth may not outpace inflation. You could lose purchasing power, If returns don’t keep up with inflation, especially if your money is tied up for a long term.
How to open and find the best IRA CDs
Opening an IRA CD is easy. Banks, credit unions and big brokerage houses offer IRA CD options, but you should shop around. The best IRA CDs will likely not be offered at the biggest banks.
Online banks typically offer the best yields because they do not have brick-and-mortar branches to maintain.
Use Bankrate’s guide to the best IRA CD rates to compare yields, account opening requirements and more.
— Libby Wells and David McMillin contributed to a previous version of this article.