You may not convert a certificate of deposit in an individual retirement account into a regular CD, but you may sell the IRA CD and use the proceeds to buy a regular CD. This type of transaction will almost always be a taxable event, and you may face penalties from the Internal Revenue Service as well. Additionally, selling an IRA CD and buying a regular one will produce two separate transaction costs.
Tax on Distribution
An IRA is a tax-advantaged account, meaning you usually get a tax deduction for contributions you make to the account. As a result, money you take out of an IRA is considered ordinary income and subject to income tax. If you liquidate a CD in your IRA and take the money out to buy a regular CD, you will receive a Form 1099-R at the end of the year indicating the amount you withdrew from your IRA. You must report this amount when you file your income tax return.
The IRS assesses a penalty tax on "early distributions" from IRAs. By IRS standards, if you take a distribution from your IRA before you reach age 59 1/2 it is an early distribution. The penalty for early distributions is 10 percent on top of the income tax you owe. Your Form 1099-R will usually indicate whether your distribution is subject to the 10 percent penalty.
A further tax implication of converting an IRA CD to a regular CD comes in the form of interest income. When you hold a CD in an IRA, the interest income you earn is tax-deferred. You are not required to pay tax on your IRA investments until you withdraw the money from the account. If you purchase a regular CD, however, you are taxed on that income in the year you receive it. Instead of not paying tax on your CD for years or even decades, you will now be paying tax on your CD every year you own it.
Exceptions to Distribution Tax
If your IRA is a Roth IRA rather than a traditional IRA, you usually are not taxed on distributions. As long as you are over age 59 1/2 and have held the account for five years, you may convert your CD to a regular CD and not pay tax on the distribution. Non-deductible contributions to your traditional IRA represent another exception. While these are uncommon, distributions of non-deductible contributions are non-taxable, but you must be able to document the contributions.
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