An individual retirement arrangement is a type of account that lets you deposit money and not pay taxes until you withdraw it, typically after retirement age. A certificate of deposit is a type of bank account where you agree to deposit money for a certain length of time in exchange for a higher interest rate. Both can offer penalties if you withdraw funds early, so they're usually not good investments for money you may need quickly, but they can be good ways to save for the long term.
TL;DR (Too Long; Didn't Read)
CDs are generally seen as medium-term investments, while IRAs are expressly designed to save money long term for retirement. In some cases, you can invest in a CD within an IRA.
CD vs. IRA
A certificate of deposit is a type of bank account. You can also sometimes open a CD through an investment broker. You generally agree to a particular length of time, called a term, when you open a CD. If you withdraw your funds before the term is up, you usually pay a penalty. In exchange, you get a guaranteed interest rate. Variations exist where you can add funds to a CD, remove them at various points with lesser penalties or opt to boost your interest rate at particular points in the life of the account. You can check with your bank or shop around in person or online to see what types of CDs are available to you.
An IRA, on the other hand, is an investment account. You can invest in lots of different things within a single IRA, from stocks to bonds to mutual funds and sometimes even certificates of deposit. You can deduct money you put into an IRA from your income taxes and then pay tax on the money when you withdraw it. You're limited to $5,500 in IRA contributions per year or $6,500 if you're over 50. You'll generally face a tax penalty of 10 percent if you withdraw money before reaching the retirement age of 59 ½.
IRA vs. Money Market Account
Another type of bank account that can deliver higher rates of return than traditional checking and savings accounts is a money market account. These generally invest your money in short-term corporate and government debt and limit you to a certain number of transactions per month, similar to a savings account, though you may have access to products typical of a checking account, like debit cards and checkbooks.
Different banks have different policies on how many withdrawals you can make in a month, and some put additional restrictions on accounts, like requiring a minimum balance. Some may simply pay more interest above a certain balance threshold.
Money market accounts are still more liquid than CDs or IRAs, so they can be a good place to put money you plan to spend or invest relatively soon. They're also insured by the Federal Deposit Insurance Corporation up to a $250,000 limit like other bank accounts.
Some brokerages also offer mutual funds called money market funds. They are similar to money market accounts at banks and are considered relatively safe investments, though they're not FDIC insured.
IRA and Certificate Risk
A CD is generally insured by the FDIC up to a $250,000 limit. Similar certificate accounts from credit unions are insured by the National Credit Union Administration. Even if you open a CD through a broker, it's usually held at one or more banks and subject to FDIC insurance. Some brokers can help you open multiple accounts at different banks with large deposits to avoid having too much for insurance.
IRAs are not insured, and you can lose money in them if your investments don't do well. You may be able to invest in lower- or higher-risk investments, including some insured bank products such as CDs, within an IRA. Historically, you can make more money investing in stocks and mutual funds than in bank products like CDs, though in exchange for the possibility of greater return you take on greater risk. Investment advisers, including those at institutions that host IRAs, can help you pick an investment portfolio that matches your desire for risk versus reward.
Early Withdrawal Penalties
You will generally face early withdrawal penalties for taking money out of a CD before its term is up or for taking money out of an IRA before you turn 59 ½. This makes these investments less of a good idea for money you may need right away.
Some people set up what is called a CD ladder, investing in CDs that mature at different dates in the future so that they always have cash available if they need it. There's not an equivalent strategy for an IRA certificate of deposit.
You can avoid early withdrawal penalties for an IRA if you use funds you withdraw for certain permitted purposes. For instance, you can withdraw up to $10,000 from an IRA to purchase your first home, even if you're under retirement age. You won't pay the normal 10 percent tax penalty, though you will owe income tax on the money at your normal tax rate.
You can also withdraw from an IRA to pay for health insurance if you're unemployed or to pay for medical expenses above 7.5 percent of your adjusted gross income. You can use funds in IRAs for certain educational expenses without penalty and can make no-penalty withdrawals if you're in the National Guard or military reserves and you're called to active duty.
Early withdrawal penalties for CDs can vary, and some do offer early withdrawal options, though usually in exchange for lower interest rates. You won't face any legal or tax repercussions for taking money out of a CD early, but you will pay fees to your bank or credit union.
About Roth IRAs
One alternative to the traditional IRA is the Roth IRA. With a Roth account, you pay tax as you normally do when you put money into the account. There is no deduction for contributions to a Roth account.
On the other hand, whatever you withdraw is untaxed, including investment earnings. If you're confident your investments will make money and suspect you will be in a higher tax bracket when you retire than when you make contributions, this can be a good option.
Your $5,500 or $6,500 contribution limit includes all of your IRA accounts, including Roth and traditional IRAs. You can't contribute more in total by opening multiple IRA accounts or multiple types of accounts.
There are Roth versions of 401(k) and 403(b) accounts also offered through certain employers. They work similarly to Roth IRAs in terms of when you are able to deduct contributions and pay taxes. Consult your employer or plan manager to see what's available.
IRA Required Minimum Distributions
After you turn 70 ½, you are legally required to withdraw money from your IRA accounts. This is known as a required minimum distribution, and you will face a potentially large tax penalty if you don't withdraw the required amount each year. The penalties can be as high as 50 percent of what you don't withdraw. Once you withdraw the money, you can do with it what you like as long as you pay tax on it, including investing it, spending it or putting it into a bank account like a CD or savings account.
- Investopedia: Certificate Of Deposit – CD
- IRS: Publication 590-A (2017), Contributions to Individual Retirement Arrangements (IRAs)
- IRS: Publication 590-B (2017), Distributions from Individual Retirement Arrangements (IRAs)
- Federal Deposit Insurance Corporation: Deposit Insurance FAQs
- Bankrate: The Pros and Cons of IRA CDs
- Investopedia: Money Market Account
- NerdWallet: How to Avoid a CD Early Withdrawal Penalty
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.