Certificates of Deposit (CDs) are offered by nearly every bank and financial institution. They are available as regular, taxable investments or can be purchased within a traditional or Roth IRA account. The main difference between IRA and non-IRA CDs is whether they are held in a regular or IRA account. They are a good investment for anyone looking for security of their initial capital, but they generally offer a low return on investment.
How CDs Work
CDs are like a timed savings account. You purchase a CD for a predetermined amount of time, and the bank gives you a certificate for the stated interest rate and expiration date. They are available for short terms, as little as a few months, or for longer terms, as long as five years, and for mid term lengths in between. Penalties are charged for early withdrawal, such as the surrender of any interest earned.
FDIC Insurance Coverage
One reason CDs are so popular is that people usually purchase them from banks that are insured by the Federal Deposit Insurance Corporation (FDIC). The FDIC is a U.S. government agency that protects depositors in insured banks in case that bank fails. So when you open either a regular or an IRA CD with an FDIC insured institution, the American government insures your savings for up to $250,000.
CDs require a minimum investment, usually around $1,000. Most financial institutions offer higher rates for larger investment amounts and for longer terms. There are no contribution limits for a regular CD. IRA CDs are subject to the same new contribution limits as any other IRA investment. If you are under the age of 50, through 2010 the maximum contribution to a Roth or traditional IRA is $5,000, and the limit goes up to $6,000 per year in 2011. There is no limit for transferring money already in an IRA account into a CD.
Buying Regular CDs
CDs are a good place to hold funds for a relatively short amount of time and for money that is being set aside for a specific purpose, like a down payment on a new house or the purchase of a new car. If you know you need the money in about six months, you may not want to risk putting it into the stock market or other investment where the principal might go down. In that case, a regular CD for a shorter time keeps your principal safe, but allows you to earn a little more interest than a savings account. Regular CDs are also a good vehicle for a portion of your emergency fund savings.
Who Should Buy IRA CDs
IRA CDs are popular with retirees who no longer earn income and do not want to put their retirement savings at risk. They can take advantage of higher yields for CDs with large balances, sometimes called jumbo CDs. IRA CDs are not recommended for younger investors who are not soon approaching retirement age. Since IRAs offer significant tax benefits, they are best suited for investments that take more risk but offer the possibility of growth and a higher rate of return.
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