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What is an IRA CD?
Investing in CDs within your IRA comes with pros and cons.
Do you want to contribute to your IRA but are concerned about taking losses? This dilemma can be significant for people nearing retirement age who can't afford to take big risks with their investments.
If you're in that position, you might consider contributing to an IRA certificate of deposit (CD). Unlike stocks and bonds, IRA CDs give you a mix of both IRA and CD features: guaranteed returns and potential tax advantages.
On the other hand, it's hard to earn rates much higher than 5% APY. You'll also face significant penalties if you withdraw the funds before reaching the age of 59 ?. Here’s what you should know before investing in an IRA CD.
Read more: The best CD rates on the market for 2024
How do IRA CDs work?
When you contribute money to an IRA, it can be invested in a mix of assets, including stocks, bonds, and mutual funds. Some IRAs also have the option to open a CD, which means you can invest in a CD as part of your IRA holdings. If your IRA offers CDs, you can usually choose from a variety of terms ranging from a few months to several years.
Like other CDs, IRA CDs managed by banks and credit unions are typically insured for up to $250,000. They also mature at a pre-set date, after which the funds might be automatically rolled into a new IRA CD. If not, you'll need to choose if you want to invest it in another asset within your IRA.
However, IRA CDs are different from traditional CDs in significant ways, mainly because most rules that apply to IRAs also apply to IRA CDs. That means you'll need to consider the tax implications (more on this later) before depositing money in one of these accounts.
How are IRA CDs different from other CDs?
IRA CDs are unique from traditional CDs because they have characteristics of both CDs and IRAs. Here's a breakdown of what makes them different:
Annual contribution limits
There's a fairly low limit on how much you can contribute to your IRAs each year, and IRA CD contributions are subject to that limit. For the 2024 tax year, the maximum you can contribute to an IRA if you're under age 50 is $7,000. For investors 50 and older, it's $8,000.
One way to invest more into your IRA CD is to use funds that are already in your IRA, since these funds don't count toward the IRS's annual limit.
Income taxes
Investing in IRA CDs can impact your income tax bill. IRA CDs are available for both traditional and Roth IRAs; the IRA type you have will determine if you're taxed on the money now or later. Here's how it works:
Traditional IRA CD: The money you contribute is not taxed until you make a withdrawal or take a distribution. This can reduce your tax bill up-front, but you'll eventually pay taxes on both the principal (the amount you deposited) and on your returns when you pull out money in retirement.
Roth IRA CD: The money you contribute is subject to income taxes for the tax year you make the contribution. However, neither your principal or interest is taxed when you take a distribution.
Read more: How to avoid taxes on CD interest
Early withdrawal penalties
With most CDs, you have to pay an early withdrawal penalty if you want to access the money before the maturity date. With IRA CDs in particular, you could also face a penalty of 10% from the IRS if you make a withdrawal before you reach age 59 ?. That said, once your CD matures, you can move the money to a different fund within your IRA — you just can’t withdraw it from your account until you reach retirement age.
Once you reach the age of 73, you will have to take distributions from your IRA, whether from your IRA CD or other assets in the portfolio.
Fees
Banks and credit unions don't usually charge fees to manage CDs, but your IRA CD may be subject to various fees ranging from $0 to $50 a year. If you invest $1,000 in a CD with 5% APY, it will take you a year's worth of interest earnings to offset a $50 fee.
How do you open an IRA CD?
The steps to open an IRA CD depend on which institution is managing the account, but the process should go something like this:
Find an IRA with CDs as an investment option: Check to see if your IRA gives you this option. Or you can compare IRA CD rates and fees at banks, credit unions, or trusted brokerages.
Provide documentation: Requested documents may include ID, your Social Security number, and bank account details.
Fund your IRA: Move funds into your account via electronic transfer, check, or rollover from another IRA.
Choose a CD: Review the available IRA CDs and choose which one you want to invest in.
Once the funds in your IRA CD mature, you'll need to ensure they're either rolled into a new CD or reinvested into another asset in your IRA. If you don't, the money will be held as cash and may not earn any returns.
Are IRA CDs worth it?
CDs are a great place to keep your savings if you need the money back within the next few months or years. For that reason, traditional CD accounts are usually a much better choice than IRA CDs, since you can get the money back without a penalty long before you reach retirement age. Traditional CDs are also less likely to have fees than IRA CDs, and they're not subject to IRS contribution limits.
However, IRA CDs are worth considering if you meet these conditions:
You want to maximize your IRA contribution but need a low-risk investment
The IRA CD matures after you reach the IRS's minimum age for penalty-free withdrawals (59 ?)
You need to take minimum distributions soon but want to avoid losing money by cashing out stocks, bonds, or mutual funds during a market downturn
Read more: Why a CD should be part of your retirement savings plan