Individual retirement accounts allow a wide range of investment options including certificates of deposit (CDs). CDs tend to offer lower returns than more risky investments, like stocks or mutual funds, but the interest rate is fixed, so your return is guaranteed. Plus, as of 2013, the Federal Deposit Insurance Corporation covers up to $250,000 of CDs and other deposit accounts in your IRA in case the bank goes out of business. But if you try to cash them out before they mature or before you can take qualified distributions, you may owe tax penalties, bank penalties, or both.
The taxes on an early IRA CD cashout depend on whether you're withdrawing from a traditional IRA or a Roth IRA. For traditional IRAs, you pay taxes on the entire amount unless you've made nondeductible contributions (contributions you didn't deduct on your taxes). For Roth IRAs, all contributions are nondeductible and you get them out first (and tax-free). But, once you start taking out your earnings, then you have to pay taxes on that part of with IRA CD withdrawal unless you're taking a qualified withdrawal. If you're under 59 1/2, Roth IRAs require that the account be at least five years old and you be either permanently disabled, taking out up to $10,000 for a first home or taking distributions as a beneficiary. If so, it all comes out tax-free.
IRS Early Withdrawal Penalties
If you're not taking a qualified withdrawal, you also get hit with a 10-percent tax penalty on the taxable portion of the withdrawal. For example, if you cash out $5,000 from a traditional IRA, you usually owe a $500 penalty. But, you can avoid the early withdrawal penalty if you qualify for an exception, like significant medical expenses, a first-time home purchase, higher education costs or medical insurance premiums when you're out of work.
If the CD hasn't matured, the bank can charge you an early withdrawal penalty even if you're taking a qualified distribution from your IRA. According to Bankrate.com, penalties average about three months of interest if the CD term is a year or less while longer CDs impose penalties of around six months of interest. For example, say you're able to take a qualified withdrawal from your Roth IRA because you're buying your first home, but all the money in your IRA is in a CD that won't mature. Even though you won't owe tax penalties, you will still owe bank penalties.
Inherited IRA Treatment
If you're taking distributions from an inherited IRA, you might be able to avoid all the penalties. First, the bank may waive the early withdrawal penalties if the CDs were bought by the decedent. For example, say you inherited an IRA containing CDs that won't mature for three years. Your bank may waive the penalties on cashing out that money early. Plus, when you take distributions as a beneficiary from an inherited IRA, the money isn't hit with the 10-percent early withdrawal penalty.
- Internal Revenue Service: Publication 590 -- Individual Retirement Arrangements (IRAs)
- Bankrate.com: Inherited IRA Withdrawals
- Bankrate.com: CD Early Withdrawal Penalties Can Sock You
- Federal Deposit Insurance Corporation: Insured or Not Insured?
- Federal Deposit Insurance Corporation: Deposit Insurance Summary