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What is an IRA CD?

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If you’re looking ahead to retirement, you’re probably asking yourself: How do I save enough money to be comfortable when I’m no longer collecting a steady paycheck?

One tool to help you get ready for those golden years is an IRA CD. Here is what you need to know about this low-risk investment.

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.

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 can be deducted from your annual income but 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 advisor 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 traditional CD.

How much you can invest: With a traditional CD, you can deposit as much as you want when you open the account. But IRA CDs have contribution limits. If you are under age 50, you can contribute up to $6,000 in 2022. If you are over 50, you can contribute up to $7,000.

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, so will the IRS. There are tax implications, including a 10 percent penalty on retirement funds drawn before you are 59 ½ 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.

If you’re not close to retirement but still want a safe, fixed-rate investment for your money, a traditional CD can offer higher earning potential. The best one-year CDs are paying more than 20 times as much as the average traditional savings account, which is at 0.11 percent APY, according to Bankrate’s rate survey of July 20.

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, CIT Bank, Ally Bank and some others offer 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 has been aggressively raising rates this year.

Pros and cons of IRA CD

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.

Pros

  • Returns are guaranteed. Investing can be scary because the market fluctuates. But CDs are fixed-rate investments, so you can be certain in advance of exactly how much you will earn. “Essentially, a CD provides a steady stream of fixed and known interest payments over the CD term and your principal balance is typically protected, often through FDIC insurance,” says Pepper.
  • Rates are rising. The recent Federal Reserve rate hikes make borrowing money more costly but result in higher yields for savers. APYs on CDs are climbing.
  • Funds are federally insured. CDs taken out at federally insured banks and credit unions are protected up to $250,000 per depositor.
  • Low fees. 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.
  • 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. “A CD ladder becomes a lot more appealing in a rising interest rate environment,” Pepper says. “We’re moving into a rising interest rate environment. With a ladder, you can get on that rocket ship as it’s going up.”

Cons

  • 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. “There is also interest rate risk in that a CD typically carries a fixed interest rate throughout its term,” Pepper says, “so if rates were to rise over the term of the CD, the investment would not be as attractive since it would be stuck paying the relatively lower rate.”
  • 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 59 ½ years old, the IRS will likely ding you, too.
  • Growth may not outpace inflation. If returns don’t keep up with inflation, you lose purchasing power, 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 like Fidelity offer IRA CD options, but you should shop around. The best IRA CDs will likely not be offered at the biggest banks.

For example, Bank of America’s current retirement CD rates top out at 0.03 percent APY, with some promotional IRA CD products offering 0.05 percent APY.

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.

Written by
Libby Wells
Contributing writer
Libby Wells covers banking and deposit products. She has more than 30 years’ experience as a writer and editor for newspapers, magazines and online publications.
Edited by
Managing editor