What Is an IRA CD?

How an IRA CD Works

IRA CDs are similar to traditional certificates of deposit (CDs). In other words, you get the benefits of a CD, which is a type of savings account in which your money is locked into a fixed term but offers a higher interest rate than traditional savings accounts.

However, IRA CDs are different than regular CDs since they are specifically earmarked for retirement savings. As a result, IRA CDs are subject to the rules and tax laws for retirement savings accounts by the Internal Revenue Service (IRS).

One of the benefits of an IRA CD—often called a retirement CD—is that you receive a fixed interest rate on your retirement savings. Fixed interest means you don’t have to worry about the fluctuation in rates. Instead, you get a steady interest income, helping you avoid the unpredictable returns of other investments, such as the stock market. However, the added safety of an IRA CD might translate to a lower rate of return versus other riskier investments.

How IRA CDs Are Similar to Regular CDs

• Open an IRA CD with a bank or credit union
• Choose a term that aligns with your savings goal
• Lock in a fixed, guaranteed interest rate
• You may pay an early withdrawal penalty if you need your money before maturity
• Can renew your IRA CD or transfer funds once it matures

How IRA CDs Are Similar to IRAs

• Use the account to save for retirement
• Get to enjoy the same tax benefits as a traditional or Roth IRA
• Contributions are limited, meaning you can’t save more than $6,000 a year in 2022 ($6,500 in 2023), and for those age 50 and older, $7,000 in 2022 ($7,500 in 2023)
• May pay IRS penalties if you need your money before age 59 ½.

Example of an IRA CD

Suppose Benny, who is 30 years old, opens a traditional IRA CD with her local bank. She deposits $3,000, and it earns 3% interest for one year. One year from now, Benny will earn $90 in interest for a total balance of $3,090.

At maturity, Benny has the option of allowing the CD to renew for the same term—one year—or she can have the funds moved into another IRA CD for a different term, such as six months or five years. Benny also gets a tax deduction of $3,000 when she files her taxes, meaning her total taxable income for that year would be reduced by the $3,000 contributed to the IRA CD.

However, if Benny withdraws the money from the IRA CD and places the funds into a non-IRA account, she'll pay an IRS penalty for early withdrawal because she's under the age of 59½. She will also have to pay income taxes on the withdrawn funds.

Although IRA CDs share many similarities to regular CDs and offer many benefits, it's important to remember that IRA CDs come with the rules and regulations of retirement accounts.

How To Open an IRA CD

You can open an IRA CD with most banks and credit unions just like a regular CD. The process usually looks like this:

1. Shop around for the best IRA CD rates online.
2. Follow the steps on that bank’s website to open your account. You can usually open an IRA CD online, but some banks may want you to call or stop by in person.
3. Fund your account.

In a regular CD, there’s typically only one way to fund your account—by transferring the money from your checking or savings account. But with an IRA CD, there are three more ways to fund your account in addition to a regular deposit:

• Rollover: If you already have an IRA, you can move some of those funds into an IRA CD. This process is known as a rollover.
• Transfer: A transfer happens when you move money from one IRA CD to another IRA CD at a different institution.
• Conversion: If you want to move money from a traditional IRA or 401(k) into a Roth IRA CD, you can do that with a conversion. But be warned: 401(k)s and IRAs have different tax treatments, so some special rules may apply.

Types of IRA CDs

Just as there are multiple types of IRAs, there are also multiple types of IRA CDs.

Traditional IRA CD

A traditional IRA CD works much like a traditional IRA. You fund your account and receive a tax deduction in the year of the contribution. Your earnings grow tax-free until retirement, and you pay income taxes on the withdrawal amounts in retirement.

You can start taking penalty-free withdrawals once you turn age 59½. However, if you make an early withdrawal before age 59½, you'll pay a 10% penalty to the IRS, and the funds will be taxed at your income tax rate.

Roth IRA CD

With a Roth IRA CD, you fund your account with after-tax dollars, meaning you don't get a tax deduction in the year of the contribution. Some of the other features include:

• Your investment earnings grow tax-free.
• You don't pay income taxes when you withdraw the funds in retirement.
• There are no required minimum distributions.
• You can withdraw your contributions at any time, including before age 59½, but you can't withdraw your earnings penalty-free until the account is at least five years old and you’re at least age 59½.

SEP IRA CD

Although not as common, some banks offer SEP IRA CDs for self-employed individuals. Similar to a traditional IRA CD, you won’t pay any taxes until you take withdrawals, and RMDs kick in at age 72.

Pros and Cons of an IRA CD

Pros Explained

• Tax benefits of an IRA: IRA CDs have all the same tax benefits as an IRA. So if you go with a Roth option, you can pay your taxes upfront, and your money will grow tax-free. If you go with a traditional IRA CD, you can defer taxes now and pay them once you retire.
• Guaranteed returns: The most significant benefit of an IRA CD is that you earn a fixed interest rate on your money, so you don’t have to worry about your account losing value right as you retire. For example, if you open a 60-month Synchrony Bank IRA CD, you'll earn a 4.26% APY for the life of the term as of Nov. 6, 2022.
• Low risk: IRA CDs are insured by the Federal Depository Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), which means your initial deposit stays intact and is never at risk of losing value.
• Good option for soon-to-be retirees: Guaranteed returns and FDIC insurance make IRA CDs a good option for current and soon-to-be retirees. However, you may give up the potentially higher returns you’d earn with a regular IRA.

Cons Explained

• Lower yields: The biggest downside to IRA CDs is that you limit your earnings potential. In most cases, a regular IRA made up of stocks, bonds, ETFs, and mutual funds will earn a higher return over time.
• Two types of early withdrawal penalties apply: IRA CDs are a double whammy when it comes to withdrawal penalties. If you need your money early, the bank may charge you an early withdrawal fee, and the IRS may make you pay taxes and penalty fees if you’re younger than age 59½.
• A minimum opening deposit is often required: Most banks have opening deposit requirements for IRA CDs. By contrast, you can open an IRA at some brokerages with as little as $0.
• May miss out on higher returns if CD rates increase: If you open an IRA CD and rates start to rise, you’re out of luck unless you go with a bump-up or step-up CD, which lets you raise your rate at least once during your CD term.
• May not be ideal if you’re decades away from retirement: Because returns are historically lower for IRA CDs than regular IRAs, they may not be advantageous if you’re more than ten years away from retirement and have plenty of time to rebound from any stock market volatility.
  

IRA CD vs. Regular CD

IRA CDs and regular CDs have a lot in common:

• Both are offered by banks and credit unions.
• Both earn a fixed interest rate.
• Both come in terms ranging from three months to 10 years.

The main differences between CDs and IRA CDS are what they’re used for and how they’re taxed. Regular CDs can be used for anything, including non-retirement expenditures such as a down payment on a house, a new car, or your kids’ future. IRA CDs are used for retirement spending and income.

There are also no tax advantages with a regular CD, and the interest earned is taxable in the year you earned it. With an IRA CD, your earnings grow tax-free and you either get a tax break now if you go with a traditional IRA CD or in retirement if you go with a Roth IRA CD. 

IRA CD vs. Roth IRA

Both IRA CDs and Roth IRAs help you reach retirement goals. Both also come with tax advantages, such as the ability to earn tax-free growth and withdrawals in retirement. But that’s about where the differences stop.

An IRA CD is considered a conservative investment because it’s FDIC-insured by a bank and has a predictable interest rate. This can be a great option if you’re close to retirement and don’t want stock market volatility messing with your returns. You still get the same tax benefits as an IRA but with a locked-in interest rate and FDIC insurance.

Frequently Asked Questions (FAQs)