An individual retirement arrangement lets you defer taxes on some of your income by putting it in a retirement account. Within an IRA, you can put money in a wide variety of investment opportunities depending on what's offered by your bank or brokerage. Among the options are certificates of deposit, specialized bank accounts with a minimum investment period and fees for early withdrawal.
TL;DR (Too Long; Didn't Read)
An IRA certificate of deposit works similarly to any other CD except that it is within an IRA. Before opening such an account, you should make sure you understand the interest rate, deposit term length and any penalties for early withdrawal.
How Certificates of Deposit Work
A certificate of deposit is an account available at many banks and credit unions. Generally, you agree to keep your money in a CD for a certain length of time in exchange for a higher interest rate. If you withdraw your money ahead of time, you must pay a penalty. When the term expires, you're usually given the option to roll the money into another CD, transfer it to another type of account or withdraw it.
Different accounts have different penalties as well as different rules for whether interest rates can change and if you can add additional funds after the CD is open. Some CDs have minimum balances or offer better interest rates if you put more money into the account. You can shop around online or by physically visiting banks to see the options available to you.
Insurance and CD Options
CDs are almost always insured by the Federal Deposit Insurance Corporation up to $250,000. If they're issued by credit unions, they're insured by the National Credit Union Administration.
You can also often invest in CDs through investment brokerages. These CDs are called brokered CDs and can deliver good rates. Some brokers will help you automatically distribute funds between banks to avoid the FDIC limit on one account if you are investing a great deal of money.
Some institutions only offer CDs and other accounts to certain people. For example, credit unions may only be open to residents of certain places or employees of certain companies. The financial institution called USAA only offers its USAA certificate of deposit accounts and other services to members of the armed services and their relatives.
How IRAs Work
An IRA is a retirement account where you can contribute funds every year, normally up to a maximum of $5,500 if you're under 50 and $6,500 per year otherwise. You do not pay tax on money you put into an IRA, but you do pay tax on money you take out, so you're effectively deferring your taxes until you retire.
This is a good deal if you expect you'll be in the same or lower tax bracket when you retire, as many people are at that point since they no longer have their traditional salary. You can withdraw money early from an IRA before you reach the retirement age of 59 ½, but you will pay tax at your normal income tax rate on the money you withdraw and also an additional 10 percent penalty to the IRS. Some exceptions apply, but you're generally incentivized to keep money in the IRA until you reach the minimum age.
Understanding Roth IRAs
Specialized IRAs called Roth IRAs allow you to pay tax on money you put into the account but not pay tax on withdrawals, including investment income. They can be a good deal if you anticipate making a good amount of money on investments or being in a high tax bracket when you retire.
Opening an IRA
You can open an IRA with a wide variety of banks, brokerages and other financial institutions. Different IRAs offer access to different investments, typically including bonds, stocks, mutual funds and index funds. IRAs can't legally be invested in collectibles like coins or art, but otherwise people are fairly free to invest in whatever they wish, provided they can find an account provider that allows it.
You can open more than one IRA, but the yearly contribution limit applies across all your IRA accounts. Workplace retirement accounts such as 401(k)s, 403(b)s and even SEP and SIMPLE IRAs have their own separate contribution limits.
IRA CD Investments
Many IRA providers will allow you to invest in certificates of deposit. Some have IRA accounts that invest exclusively in CDs, and some offer CDs among a range of investments. Shop around to find what you're looking for in a provider if you wish to go this route.
Traditionally, many IRA investors opt to invest in stocks or other higher-risk and hopefully higher-return investments than CDs and other bank accounts in an effort to have more money available to retire. However, investors nearing retirement may wish to take on something less risky, in which case an IRA CD might be a good possible choice for some or all of your funds. Roth IRAs are often not a good choice for low-return investments like CDs, since their benefit comes from not paying tax on investment income.
Early Withdrawal Penalties
CDs usually carry early withdrawal penalties from the issuing bank, and IRAs can incur early withdrawal penalties from the IRS. If you have money in an IRA CD and withdraw it before the CD term is up while you're under 59 ½, you'll effectively face two penalties.
Neither an IRA or a CD is generally a good vehicle for money that you may need right away. IRAs are usually considered long-term investment vehicles, and CDs are good for medium-term investment at low risk.
Some people construct what are called CD ladders, featuring multiple CD accounts that mature at different dates in order to have cash available at regular intervals in case of an emergency or if a good investment opportunity opens up. This can help prevent having to pay CD withdrawal penalties, but it won't help avoid IRS penalties if the CDs are in an IRA.
IRA Early Withdrawal Exceptions
There are certain cases when you can withdraw money early from an IRA with no tax penalty. You will simply pay the tax on the money you withdraw as ordinary income. If you're disabled or paying medical bills in excess of 7.5 percent of your adjusted gross income, or if you're unemployed and need to buy health insurance, you can do so. You can also withdraw money early in certain circumstances if you are called to active duty as a member of the National Guard or military reserves. First-time homebuyers can withdraw up to $10,000 with no penalty to buy a house, and certain educational expenses also qualify for no-penalty withdrawals. Penalties paid to a bank may still apply if your money is in a CD as well as within an IRA.
Mandatory Minimum Withdrawals
After you reach age 70 ½, you must start taking a minimum amount out of your IRA each year. The IRS publishes tables showing how much you must withdraw based on your age and account balances. If you don't do so, you can face high tax penalties of up to 50 percent of the amount you should have withdrawn. This is higher than any federal tax level you would pay on withdrawals. Some institutions may allow you to waive your fees for taking money out of a CD early if doing so would otherwise cause you to owe a tax penalty for a missed minimum distribution.
- NerdWallet: How to Avoid a CD Early Withdrawal Penalty
- IRS: Publication 590-A (2017), Contributions to Individual Retirement Arrangements (IRAs)
- IRS: Publication 590-B (2017), Distributions from Individual Retirement Arrangements (IRAs)
- Investopedia: Certificate Of Deposit – CD
- Federal Deposit Insurance Corporation: Deposit Insurance FAQs
- USAA: Join
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.