Individual Retirement Account certificates offer a few key benefits for conservative investors. IRA certificates combine the safe, fixed interest return of a regular CD with the tax benefits of an IRA. The tax benefits you receive depend on whether your invest in a traditional IRA certificate or a Roth IRA certificate.
As of 2012, you invest up to $5,000 a year into your IRA; $6,000 a year if you are 50 or older. When you put money in a traditional IRA, you get a tax deduction for your contribution. This means that your investment into CDs reduces your tax bill for the year, up to the annual contribution limit. The Roth IRA on the other hand doesn't give a tax deduction for your contributions. If you want to buy Roth IRA certificates, you'll need to pay for the investment with after-tax money.
Both the traditional and Roth IRA delay taxes on your certificate income. As long as you reinvest your interest earnings back into the IRA account, either into another CD or in another investment, you won't owe any taxes. If you invested in CDs through a regular bank account, you would owe income tax on your interest earnings each year, even if you reinvested the money right into another certificate. As a result, you get a significantly better after-tax return through both IRA accounts.
You are allowed to start making retirement withdrawals of your certificate earnings when you turn 59 1/2. When you take money out of a traditional IRA, your entire withdrawal is taxable. When you take money out of a Roth IRA in retirement, your entire withdrawal is tax-free, meaning you never have to pay tax on your certificate income. A traditional IRA certificate gives you more of a tax benefit while you are saving for retirement whereas the Roth IRA is better for taxes during retirement.
The IRS created the IRA tax advantages to help Americans save for retirement. If you take money out of your either IRA certificate before you turn 59 1/2, you're making an early withdrawal. For the traditional IRA, you'll owe income tax plus a 10 percent penalty on all early withdrawals. For the Roth IRA, you can take out the money you contributed into the account, but early withdrawals of your certificate income are charged income tax plus the 10 percent penalty.
Dylan Armstrong specializes in insurance, investing and retirement planning. He has also worked as a life and health insurance salesman and holds a Bachelor of Science in finance from Boston College.