Certificates of deposit (CDs) provide you a guaranteed rate of return over a certain time frame, which can make them useful investments in your individual retirement account because you won't lose your retirement money. However, when a CD matures inside an IRA, the effects are different than when a CD matures that isn't in an IRA.
When a CD in your IRA matures, you're allowed to move the money to another investment without paying any bank early withdrawal penalties. For example, you could take the money from the maturing CD and move it to a mutual fund -- within the same IRA -- that you think will bring you a higher rate of return. If you tried to move the money before the CD matured, you would owe the bank's early withdrawal penalties.
Just because you can remove the money from the CD without a bank penalty doesn't mean you can take it out of your IRA without a tax penalty. Since you're under 59 1/2 years old, you're taking an early withdrawal if you take the money out of your IRA completely, which means that the taxable portion of the withdrawal is hit with a 10 percent additional tax on top of the ordinary income taxes. For traditional IRAs, all of the withdrawal is taxable income unless you've made nondeductible contributions. In that case, you prorate your withdrawal between the a return of nondeductible contributions, which come out tax-free, and the remainder of the account, which is taxable. For Roth IRAs, you get the value of all your contributions out tax-free first, but then any earnings withdrawn are taxable.
No Taxes Due
Typically, when a CD matures, you have to report the interest you receive as part of your taxable income for the year. However, since the CD is held in your IRA, you don't report any taxable income -- at least immediately. IRAs offer tax-sheltered savings, which means that as long as you leave the money in the IRA, you won't owe any taxes on the earnings. Plus, if you have a Roth IRA and wait until you can take qualified distributions -- meaning you've had a Roth IRA for five years and you're either 59 1/2, permanently disabled or using up to $10,000 for a first home -- you won't ever pay taxes on the withdrawals, including the interest from the CD.
Typically, your bank will automatically reinvest the money in a new CD of the same length, but not necessarily the same interest rate, after a certain period of inaction. For example, say the renewal window is 10 days and your five-year CD just matured. If you don't act, your bank may automatically sign you up for another five-year CD. While you might not be concerned about the term because retirement is decades away, you might not be happy if the interest rate is lower than you expected.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."