All You Need to Know About IRA Certificates of Deposit (CDs)

By Paulina Likos · June 16, 2022 · 7 minute read

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All You Need to Know About IRA Certificates of Deposit (CDs)

An IRA CD is simply an individual retirement account (IRA), in which the investor has opened one or more certificates of deposit (CDs).

In other words, an IRA CD is a traditional, Roth, or other type of IRA account where the funds are invested at least partly in CDs.

Investing in CDs within an IRA can offer some tax advantages. Keep reading to learn more how an IRA CD works, the pros and cons of using an IRA CD, and whether it might make sense for your retirement plan.

Recommended: What is an IRA and How Does it Work?

What Is an IRA CD?

An IRA CD is an IRA where your money is invested in certificates of deposit. To understand why this might make sense as part of an overall retirement plan, let’s consider the two types of accounts.

How Does a CD Work?

A CD or a certificate of deposit is a type of savings or deposit account that offers a fixed interest rate for locking up your money for a certain period of time, known as the term. An investor deposits funds for the specified terms (usually a few months to a few years), and cannot add to the account or withdraw funds from the account until the CD matures.

In exchange, for keeping your money in a CD, the bank will offer a higher interest rate compared with a traditional savings account. But the chief appeal for retirement-focused investors is that CDs can provide a steady rate of return, versus other securities in a portfolio which may entail more risk.

Recommended: How Investment Risk Factors into a Portfolio

How Does an IRA Work?

An IRA or individual retirement account is a tax-advantaged account designed for retirement planning. There are different IRA types to choose from, such as a traditional IRA, Roth IRA, or SEP IRA. By contributing to this type of account, you can have your money grow tax-free or tax-deferred, depending on the type of IRA you open.

Think of an IRA as a box in which you place your retirement investments. With an IRA, investors have the flexibility to invest in a variety of securities for their portfolio.

For this reason, it might make sense for some investors to include CDs as part of their asset allocation within the IRA.

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How Do IRA CDs Work?

If you choose to put your retirement money in an IRA, you have the chance to choose investments that might include stocks, mutual funds, bonds — and also CDs. By investing in CDs within an IRA, you can add to your portfolio’s diversification. Unlike equities, CDs can offer a steady rate of return.

Also by investing in an IRA CD, you no longer have to pay taxes on the interest gains, and the money can grow taxed deferred.

But if you withdraw funds prior to the CD’s maturity date, you will face an early withdrawal penalty. Once the IRA CD matures, you can either renew it or take your money and invest it in the stock market for potentially higher returns.

How much can you contribute to an IRA CD? It depends on the type of IRA account you choose. Traditional and Roth IRAs have contribution limits of $6,000 per year, or if you are 50 or older, the contribution limit is $7,000 per year. The contribution limits for SEP IRAs are typically higher.

If you choose an IRA CD with a bank or credit union backed by the Federal Deposit Insurance Corp., or FDIC, your money in the IRA CD is insured for up to $250,000. This means that if the bank goes under for any reason, your retirement funds are covered up to that amount.

Which CDs Can You Use in an IRA CD?

Opening an IRA CD is only the first step. Next, investors must consider which investments to place in the account.

You can invest in stocks, bonds, and other investments — including CDs. You can choose to put your money in various types of CDs, including short-term CDs, long-term CDs, jumbo CDs.

You can even create a CD ladder within your IRA to help provide steady income.

Pros of IRA CDs

IRA CDs have unique characteristics that can benefit account holders as they think about how to handle their retirement funds:

•   Compared to investing in the stock market where investment returns can be volatile and unpredictable, IRA CDs are low-risk cash investments that guarantee a fixed return.

•   With an IRA CD, there are similar tax benefits that come with a traditional IRA. Investors can enjoy tax benefits such as growing your account with pretax dollars while having your earnings accumulate tax-deferred until you reach retirement.

Cons of IRA CDs

There are some cons associated with IRA CDs to keep in mind:

•   With an IRA CD, you have to keep your money locked away for a period of time that varies depending on the maturity date you choose. During this time, you cannot access your funds in the event you need capital.

•   In the event you decide to withdraw cash prior to the IRA CD’s maturity, you will incur early withdrawal penalties. After age 59 ½ there is no penalty for withdrawing cash.

•   While putting your retirement funds in an IRA CD is a safer and lower-risk option than investing in the stock market, the returns can be quite low. If you are in retirement and are concerned about the stock market’s volatility, an IRA CD could be a safer option than other securities, but if you are many years away from retirement, an IRA CD may not yield enough returns to outpace inflation over time.

Who Should and Should Not Invest in an IRA CD?

IRA CDs are a safe way to invest money for retirement, but are best suited for pre-retirees who are looking to de-risk their investments as they approach retirement age.

However, if you are many years away from retirement, an IRA CD is probably not the best option for you because they are low-risk and low-return retirement saving vehicles. In order to see growth on your investments you may need to take on some risk.

If you decide an IRA CD is the right option for you, you also must determine if you are comfortable with keeping your money stowed away for a period of time. Account holders can choose the length of maturity that best suits them.

Typical Process for Opening an IRA CD

The first step is to open an IRA at a bank, brokerage, or other financial institution. Decide if a traditional, SEP, or Roth IRA is right for you. You can set up the IRA in-person or online. Once you open an IRA account, now you can buy the CD.

Choose the CD that fits your minimum account requirements and length of maturity preference. Typically, the shorter CD maturity, the lower the minimum to open the account. When considering maturity, you also should compare rates. The longer the maturity the higher the rate of return.

The Takeaway

If you’re looking to add diversification to the cash or fixed-income part of your portfolio, you might want to consider opening an IRA CD — which simply means funding a CD account within a traditional, Roth, or SEP IRA. Bear in mind that CDs offer very low interest rates, though, and your money might see more growth if you chose other securities, such as bonds or bond funds.

That said, because CDs are very low risk and you earn a steady rate of return, it might make sense for your retirement plan to give up growth potential in favor of that steady return.

If you’re thinking about how to earn a steady rate of return on your savings, consider an account with SoFi. When you open a high-yield bank account, you pay no SoFi account fees or management fees. With the special “vaults” feature you can separate your savings from your spending, and earn competitive interest on your total balance.

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What is the difference between an IRA CD and a regular CD?

A standard CD is a separate account you open at a bank or credit union. An IRA CD is where the CD is funded within the IRA itself.

With a regular CD you withdraw the funds penalty free when the CD matures. With an IRA CD you can withdraw the funds penalty free starting at age 59 ½, per the rules and restrictions of the IRA.

What happens when an IRA CD matures?

Once your IRA CD matures, you’ll receive the principal plus interest. Then you can either leave the IRA CD as is or renew it. You cannot withdraw the funds from an IRA CD until age 59 ½, as noted above.

Can you lose money in an IRA CD?

It’s unlikely as IRA CDs are low-risk. If you open an IRA CD with a federally insured institution, your funds can be covered up to $250,000.

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