When the stock market is volatile and interest rates are up, those at or near retirement might consider an IRA CD for part of their retirement savings. An IRA CD is a safe, FDIC-insured investment that combines the tax benefits of a traditional or Roth IRA with the predictable interest rates and income of a certificate of deposit (CD).
However, IRA CDs aren’t right for everyone and may be too conservative for many. By looking at their structure and average returns, you can make a more informed choice when considering different investments for your retirement savings.
What is an IRA CD?
An IRA CD is an IRA where you invest funds in CDs instead of other assets like stocks and mutual funds. These unique investments combine the safety and predictability of a CD with the tax advantages of an IRA.
You can open an IRA CD at a bank or a brokerage firm. Credit unions offer similar investments called IRA share certificates. Whichever you choose, your CD or share certificate enjoys all the benefits of your IRA.
How do CD IRAs work?
Luckily, a CD IRA works the same as investing in a regular CD—you just buy the CD using money in your IRA. You’ll commit a lump sum for a set term, often anywhere from one month to 10 years. In return, you receive a fixed interest rate often higher than a savings account yet lower than the stock market.
Your CD investment also enjoys insurance against bank failure for up to $250,000, and there is little to no risk that your investment can lose value. When you invest through a bank, you’re protected by Federal Deposit Insurance Corporation (FDIC) insurance. Share certificate investments through credit unions are insured by the National Credit Union Administration (NCUA).
While a CD IRA protects your principal, you may have to pay a penalty for early withdrawal if you need the money in your CD or share certificate before it matures. You may also lose the interest you would have earned had you held it through the end of the term.
When you have a CD IRA, the interest you earn is tax-deferred until you withdraw it from the IRA. If you invest through a traditional IRA, your withdrawals will eventually be taxed as regular income. If your CD is inside a Roth IRA, your withdrawals will be tax-free as long as they are qualified.
CD vs. IRA CD: What’s the difference?
The type of account you use to invest in a CD makes up the lion’s share of differences between CDs and IRA CDs.
Taxes
With a regular CD, the interest is taxed as regular income in the year it’s earned. With an IRA CD, however, your interest grows tax-deferred until retirement. Your IRA withdrawals are either taxed as ordinary income (traditional IRAs) or not taxed at all (Roth IRAs).
Contribution limits
When you buy CDs through a regular bank account, you can invest as much as you’d like each year—though it is important to be aware of the $250,000 FDIC or NCUA insurance limit. However, when you buy CDs in your IRA, you’re subject to annual contribution limits set by the IRS.
For instance, say you have $10,000 in your IRA that you want to use to invest in CDs. If the $10,000 is already in your IRA, you don’t need to worry about annual contribution limits. But you need to be concerned with annual limits if you need to put $10,000 in your IRA to buy these CDs—which you cannot. Instead, you can only contribute up to the annual IRA contribution limit. For 2023, the IRA contribution limits are $6,500 if you are under 50 and $7,500 for those 50 and older.
Early withdrawal penalties
You’ll likely pay an early withdrawal penalty with a regular CD if you take the money out early. With an IRA CD, you could face a double early withdrawal penalty: one for the CD and the other from the IRS. The penalty on the CD will vary by bank. If you withdraw funds from an IRA before age 59.5, you may be taxed on the earnings and subject to an additional 10% penalty.
The bottom line? IRA CDs provide tax-deferred growth, but your contributions are limited, and there are additional penalties if you need to access your money early.
IRA CD pros and cons
An IRA CD can be a helpful addition to your retirement portfolio, adding some predictability to what can otherwise feel like a rollercoaster ride. But there are some key downsides to consider before opening a CD IRA.
Pros
- Safety. Your investment is FDIC or NCUA insured up to $250,000, and most CDs and share certificates have no risk of losing value.
- Guaranteed return. You know exactly how much you’re doing to earn throughout your CD or share certificate’s term.
- Tax-deferred growth. Your interest is tax-deferred, allowing it to compound more quickly than a regular CD.
- Predictable income. Knowing exactly how much interest your CD or share certificate will generate can help when working with a fixed income in retirement.
Cons
- Multiple accounts to track. You’ll have multiple accounts to track if you’re chasing rates and open CD IRAs at multiple banks or credit unions.
- Withdrawal Penalties. CDs almost always come with early withdrawal penalties, and you will have to pay additional penalties if you make an early withdrawal from the IRA.
- Lack of liquidity. Since you’re locked into a CD or share certificate for a fixed term, accessing your cash in an emergency could be difficult.
- Less upside. Your return on an IRA CD is likely to be lower than a diversified portfolio that includes stocks and bonds.
“In order to get the best yields, you’re going to have to shop around and find the banks offering the most attractive rates at the time you’re funding the IRA,” says David Schneider, a certified financial planner at Schneider Wealth Strategies in New York, NY. “That could mean opening lots of small accounts at different institutions based on what was attractive at the time, which can be a nightmare to manage as the CDs mature.”
Who should consider an IRA CD?
An IRA CD could be attractive if you want to protect some of your retirement savings in a conservative and relatively risk-free investment. For instance, say you want to shield one year’s worth of living expenses from stock market fluctuations. In this case, an IRA CD could be a reasonable way to achieve that goal and still benefit from a competitive interest rate and tax-deferred growth.
A CD in your IRA could also act as an alternative to the traditional bond portion of your retirement portfolio. “If you compare a CD with a maturity of five years or less to a corporate bond of the same maturity, you’re usually going to get a better yield with a CD,” says Schneider. He also highlights that CDs are FDIC-insured, and corporate bonds are not, which could make them even more attractive for risk-averse investors.
However, CD IRAs aren’t ideal for everyone—especially younger investors looking to grow their assets as they work towards retirement.
“Your IRA is supposed to be a long-term retirement savings vehicle, and I wouldn’t typically recommend holding a short-term investment there,” says Derek Pszenny, an accredited investment fiduciary (AIF) and co-founder of Carolina Wealth Management in Pinehurst, NC. “You’d be better off investing in a higher volatility investment that can give you better returns.”
Best CD types for a CD IRA
For the most part, finding the best IRA CD is similar to finding the best regular CD.
“The biggest thing you’d want to look out for is that you stay below the FDIC limits,” says Pszenny. This means ensuring that your IRA CDs or IRA share certificates remain at or below $250,000 per financial institution. Once you arrange your accounts so all your assets are fully protected, you can shop for the best rates, Pszenny says.
Some banks and credit unions might offer specific IRA CDs or IRA share certificates, but others will let you hold regular CDs and share certificates in your IRA. Your best bet is to call customer service at your financial institution of choice to ask which CDs and share certificates are IRA-eligible.
To ensure you’re always getting the best available rate, you could build a CD IRA by laddering your CDs or share certificates. With this strategy, you invest in multiple CDs with different maturities—a selection of 3-month, 6-month, and one-year CDs or share certificates. As each one matures, you can cash out to cover expenses or reinvest the money into a new CD at the best rate of the day. Laddering can provide a steady stream of income, scheduled liquidity, and help ensure you’re always getting the best rate of return, which you can often find in longer-term CDs.
“In general, by laddering and taking your maturing dollars and putting them in a longer-term CD, you’ll end up averaging the higher rates from longer-term CDs,” says Schneider.
Frequently asked questions
Which banks have the best IRA CD rates?
When it comes to IRA CDs, online banks often offer the best rates. With low overhead, they can pass on more yield to customers. Comparing CD rates at several banks can help locate the best rate and terms for your goals.
Can I buy a CD in my IRA account?
Yes, you can buy a CD in your IRA account. You can also buy share certificates, the credit union equivalent of CDs, in your IRA.
What are the benefits of an IRA CD?
An IRA CD is a low-risk, insured investment that protects your principal and provides a guaranteed rate of return and tax-deferred growth. While the rate of return is generally less than the broader stock and bond markets historically offer, some investors are willing to trade market volatility for lower rates.
