IRA vs. CD: What’s the difference?

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The individual retirement account (IRA) and the certificate of deposit (CD) are both accounts built for saving, but there are some key differences.

  • An IRA is a retirement investing account that offers tax advantages. You can hold a range of investments within an IRA, including a CD.
  • A CD is a financial product where you deposit funds for a set period of time in exchange for a guaranteed rate of return.

What to know about IRAs

Definition: An IRA is an investment account that offers certain tax advantages that incentivize consumers to save for retirement. An IRA holds investments within it, so you don’t technically invest in an IRA. For example, within an IRA, you can invest in stocks, bonds, exchange-traded funds (ETFs), CDs and more.

Types of IRAs: There are many types of IRAs, but the two most popular are the Roth and traditional. The differences between these two largely relate to when you receive the tax benefit. With a Roth IRA, you invest money you’ve already paid taxes on and can withdraw the money (including any earnings) tax-free in retirement. With a traditional IRA, you invest pretax money but will pay taxes when you withdraw the money in retirement. Traditional IRA withdrawals are taxed as ordinary income.

How much you can save: Traditional and Roth IRAs have contribution limits. The total (between all of your IRAs) contributions for IRAs is $6,000 per year for people under age 50. Those 50 and older are able to contribute an extra $1,000 in catch-up contributions for a total limit of $7,000.

Income limits on IRAs: There are no income limits on traditional IRAs, so anyone can open and contribute to one. There are income limits on Roth IRAs, however. Consult the IRS’ Roth IRA income limits table to see if you’re eligible to contribute to a Roth IRA.

How to open an IRA: You’ll need to go through a bank or broker to open an IRA. IRAs are individually owned. You can’t open a joint account with a spouse or child, so if you’re looking to open a retirement savings account with another person, an IRA isn’t the right choice.

Rules on withdrawing money: With a traditional IRA, you can’t make penalty-free withdrawals before age 59 1/2. There are some exceptions, though, such as using some of the money on a first-time home purchase. At age 72 and over, you must make mandatory withdrawals from a traditional IRA.

You also can’t make penalty-free withdrawals before age 59 1/2 with a Roth IRA. Withdrawals must also meet the five-year rule, meaning you can’t make a withdrawal before five years have passed since your first account contribution. There are no required minimum withdrawals with a Roth IRA, however. And there are exceptions to penalty-free withdrawals, such as using some of the money for a first-time home purchase.

Bankrate insight
IRAs offer tax advantages to help consumers save for retirement. You can invest in a wide range of assets within an IRA.

Pros and cons of IRAs

Pros

If you don’t have access to a 401(k) through your employer, an IRA is a great way to save up for your retirement. Depending on the type of IRA, the money you put toward your account may be tax-deductible and withdrawals can be tax-free. IRAs also give you the flexibility to invest in a wide range of assets, including stocks and bonds.

Cons

Unlike CDs, IRAs are not insured by the Federal Deposit Insurance Corporation (FDIC). IRAs are also for individuals only — you cannot open a joint account with another person. Additionally, IRAs are meant for retirement savings. Depending on your age, retirement could be decades away. If you access the money in your IRA before age 59 1/2, you will be charged a 10 percent penalty on the amount you withdraw, in addition to the regular income tax owed on the withdrawal.

What to know about CDs

Definition: CDs are financial products that have a fixed interest rate along with a set length of time for the account. At the end of that term limit, which is also known as the maturity date, you have the option to withdraw the money from the CD. If you don’t withdraw the money, the CD may auto-renew, so be aware of the maturity date.

CDs typically have higher interest rates than savings accounts but offer lower returns than riskier investments such as stocks. CDs are better for shorter-term savings goals (think a few months to three years) and those living on a fixed income. Meanwhile, riskier investments such as equities are better for longer-term savings goals that allow you to ride out any dips in value and benefit from higher long-term growth rates. You can hold these types of investments within an IRA.

Types of CDs: There are multiple types of CDs. The traditional CD is the most common type. With a traditional CD, you deposit a fixed amount of money for a set term (such as six months, one year or three years) and receive a fixed interest rate.

How much you can save: Limits on how much you can save in a CD vary by financial institution. Standard CDs may have a minimum deposit requirement of $10,000, $1,000, $500 or even $0. Meanwhile, some institutions may offer jumbo CDs that require a minimum of $500,000. If you’re considering depositing a sizable amount, pay attention to deposit insurance. CDs that are held at FDIC-insured banks or National Credit Union Administration (NCUA)-insured credit unions are insured up to $250,000. Any money in the CD above that threshold — whether it’s the deposited money or the interest earned on the account — would not be insured if the institution shuttered. If you’re in a position to save more than $250,000 in a CD, it is advisable to the funds between two CDs at separate financial institutions.

However, if you’re investing in a CD that’s within an IRA — either a Roth or traditional — you’ll only be able to save up to the IRA contribution limits mentioned earlier.

Income limits on CDs: There are no income limits on CDs. However, if you invest in a CD that’s within a Roth IRA, you will be subject to the Roth IRA income limits.

How to open a CD: CDs are available at banks, credit unions and brokerages. You can simply join a bank or become a member at a credit union to open one of the institution’s CDs. At a brokerage, you may be able to open a standard CD just as you would at a bank. However, if you want to open a CD within an IRA, you will need to first open the IRA and then select the CD as an investment inside the IRA.

Rules on withdrawing money: If you withdraw the money before the end of the term, you’ll most likely have to pay a penalty fee. Penalties for early withdrawal can be stiff and will erode your earnings, and possibly your principal. Some financial institutions offer no-penalty CDs that let you access the money before the maturity date.

Bankrate insight
With a CD, consumers deposit a fixed amount of money for a set period of time and fixed interest rate. CDs are best for short-term savings goals 

Pros and cons of CDs

Pros

CDs can be opened as a joint account with a spouse or child. FDIC-insured banks and NCUA-insured credit unions will insure your CD for up to $250,000. CDs are also low-risk accounts that tend to pay higher interest rates than typical savings accounts.

Cons

Most CDs charge a penalty for making early withdrawals. While CDs may pay a guaranteed interest rate that’s higher than the typical savings account, they don’t match the long-term average return of riskier investments such as equities.

Determine how IRAs and CDs fit into your financial plan

IRAs and CDs are very different financial products. You don’t necessarily have to pick one or the other; both accounts may make sense for you.

For example, you could contribute to a Roth IRA that holds an ETF with the purpose of building long-term wealth to fund your retirement. At the same time, you could open a three-year CD to earn interest on money earmarked for a home down payment.

Deciding whether to open an IRA or CD (or both) depends on your financial goals. Leverage the tax advantages of IRAs to save for retirement. Consider a CD when you have a short-term savings goal and want to protect your principal.