What Is an IRA CD?

 Tips for buying CDs and whether you should own one in an IRA. 

Laura Adams, MBA
5-minute read
Episode #304

A Money Girl listener named Evan says:

“Your book, Money Girl’s Smart Moves to Grow Rich, and weekly podcast have helped me get my finances together. But I’m still confused about the IRA CDs that many banks offer. How do they compare to regular IRAs?”

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In this episode I’ll tell you whether an IRA CD should be a part of your retirement plan and give 4 tips for buying CDs.

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What Is an Individual Retirement Arrangement (IRA)?

An IRA is a special type of account that comes with big tax breaks, which makes it a smart way to accumulate your retirement nest egg. IRAs are available to just about everyone, but many shy away because they don’t understand how they work.

Here’s one of the most important IRA facts to know: An IRA itself is not an investment. Think of an IRA like a basket where you hold different kinds of investments and assets that get favorable tax treatment.

The money you put in an IRA can be invested in securities like stocks, bonds, or mutual funds. Or it can be held in non-investment accounts like a savings or certificate of deposit (CD).

What you put in an IRA is up to you because you manage every aspect of it. You open the account, send contributions, and choose how to allocate your money.

There are different kinds of IRAs for individuals, the self-employed, and business owners. Additionally, there are different types, including traditional IRAs and Roth IRAs.

The major difference between a traditional and Roth IRA is how you’re taxed. With a traditional IRA, you pay tax in the future when you take withdrawals. With a Roth IRA, you pay tax upfront and enjoy withdrawals that are completely tax-free down the line.

Related Content: What’s the Difference Between a Traditional and Roth IRA?

What Is an IRA CD (Certificate of Deposit)?

The IRA CD that Evan asked about is simply a CD that’s owned within either a traditional or a Roth IRA. A CD is a bank product that pays higher interest than a regular savings account because you give up use of your money for a set period of time.

For example, you could purchase a $5,000 CD with an annual percentage yield of 1.35% and a term of 4 years. At the end of the term, or maturity, the CD would be worth about $5,275. If you withdraw money before a CD term is up, generally you get hit with a steep penalty.

As I mentioned, a CD is just one type of product you could own in an IRA. A CD can also be owned outside of an IRA; however, the earnings would be taxable.  

Advantages and Disadvantages of an IRA CD

Banks promote IRA CDs because they’re extremely safe places to stash money for retirement. At FDIC-insured institutions, deposit accounts held in IRAs get up to $250,000 of coverage in the event of a bank failure.

However, the FDIC never insures money you put in investments, such as stocks, bonds, or mutual funds—even if you purchase them through an insured bank. So remember that FDIC insurance only applies to your bank accounts, such as checking, savings, and CDs held inside of or outside of an IRA.

The major drawback to owning CDs in an IRA is that your money is locked away earning very low returns. Typically, CD terms range from 6 months to 5 years. Plus, you usually have to make a minimum deposit, such as $1,000, to purchase a CD.

If you have many years to go before retirement, earning just 1% or 2% on CDs probably won’t be enough to reach your goals. That low rate of growth won’t even keep up with inflation, which historically has been about 3%.

So, unless you’re close to retirement or are already retired, putting a large amount of your retirement savings into CDs is probably much too conservative. Younger investors need at least half of their portfolio invested in stocks or stock funds in order to beat inflation and accumulate enough money to fund a long retirement.

Related Content: Investing Tips: How and Where to Invest the Easy Way

4 Tips for Buying CDs

If you decide to add CDs to your retirement or non-retirement portfolio, follow these 4 tips to make sure you’re getting the best deal:

Tip #1: Use an FDIC-Insured Bank

Not all financial institutions that sell CDs are actually insured by the FDIC. Use the Bank Find tool at fdic.gov to make sure. Additionally, if you buy a CD through a broker, verify that he or she will only place your funds into a CD account at an insured bank.

Tip #2: Research Early Withdrawal Penalties

Though you may have the best intentions of keeping a CD until it matures, always know what the early withdrawal penalty would be, just in case. If you own a CD inside a traditional IRA, you’d also have to fork over income taxes plus an additional 10% penalty if you withdraw funds before age 59½.

Tip #3: Understand the Renewal Terms

There are many different types of CDs, so review the account agreement carefully. Make sure you know when a CD matures, if it renews automatically, and what the new interest rate would be.

Tip #4: Beware of High Advertised Rates

When you find CD interest rates that are advertised well above the industry averages, be wary. The product may not be a true FDIC-insured account or it could be a marketing ploy to sell you another financial product.

To sum up, an IRA can be opened at just about any financial institution, including banks, mutual fund companies, and brokerages. Then it’s up to you to decide whether adding CDs to your retirement basket is the right financial move.

More Articles and Resources You Might Like:

What Is a CD?
Your Guide to the Roth IRA, Part 1
How to Use a SEP-IRA Retirement Plan
How Much Money Do You Need to Retire?
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About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.