An individual retirement account (IRA) is a tax-advantaged account that can hold a variety of investments, including certificates of deposit (CDs).
You might think of a retirement account as having mutual funds or target-date funds (which are also common options). Investors may also want to include CDs in an IRA because these savings vehicles are low risk and typically pay a fixed interest rate, which can balance out other assets in your IRA portfolio.
What Is an Individual Retirement Account (IRA)?
An IRA is a retirement savings account that offers tax advantages and allows individuals to save for retirement over the long-term.
There are different types of IRAs, including traditional and Roth IRAs, each with its own tax treatment and contribution limits. But any kind of IRA is like a container that holds a range of different assets. It’s up to you as the investor to decide whether one or more CDs should be part of that mix. You can include a CD in any type of IRA.
Types of IRAs
There are two main types of IRAs to choose from.
• Traditional IRAs are funded with pre-tax dollars, and qualified withdrawals are subject to ordinary income tax. You’re required to begin taking minimum distributions, or RMDs, at age 73 (assuming you turn 72 after Dec. 31, 2022).
• Roth IRAs are funded with after-tax dollars and allow you to make qualified withdrawals tax free. There are no RMDs for the original account holder, regardless of age, but RMDs generally apply to inherited Roth IRAs.
While the tax treatment for each type of IRA is different, the same limits for annual contributions apply to both. The regular IRA maximum contribution is $7,000 for tax year 2024, with an additional $1,000 in catch-up contributions allowed if you’re 50 or older.
Traditional and Roth IRAs offer access to a variety of investments, including index funds, exchange-traded funds (ETFs), target-date funds, stocks, bonds, and CDs. It’s possible to open either type of IRA online, even if you already have a 401(k) or similar workplace plan.
Recommended: How to Open an IRA: Step-by-Step Guide
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IRA Contribution Rules
There are, however, some rules regarding who can contribute to each type of IRA.
• Generally, you can make contributions to a traditional IRA regardless of income. Maxing out IRA contribution limits can help you save more, but how much of your contributions are tax-deductible depends on your income, filing status and whether you’re also covered by a retirement plan at work.
• With Roth IRAs, you must be within certain income limits to make a contribution. If you’re a single filer and your modified adjusted gross income (MAGI) $161,000 or more, or if you’re married and filing jointly and your MAGI is $240,000 or more, you’re not eligible to contribute to a Roth IRA.
Recommended: Calculate Your IRA Contribution Limits
What Is a Certificate of Deposit?
A certificate of deposit, or CD, is a type of time-deposit account available through a bank or credit union. When you put money into a CD, it’s locked up for a set time period: e.g., six months, one year, three years, and so on. During that time, with most types of CDs, your deposit earns a fixed rate of interest.
CDs are often good options for saving for shorter or mid-length goals, such as a home down payment, although they can be leveraged for longer-term savings, as well. Most CDs are insured against loss by the FDIC (or NCUA, if your CD is with a credit union) for up to $250,000.
Rules for CDs
There is typically a penalty for withdrawing the money before the CD matures, meaning it reaches the end of its term. Once the CD matures, you can either withdraw your initial deposit and the interest earned, or roll the entire amount into a new CD.
Typically, CDs have fixed interest rates, meaning you can predict how much interest you’ll earn by the time the CD matures. It’s possible to find banks that offer a variable-rate CD, though they’re less common. Variable-rate CDs have an interest rate that’s tied to a particular benchmark, such as the prime rate. When the benchmark rate goes up or down, the CD rate typically follows suit.
Including CDs in Your IRA
As noted above, when you open an IRA through a brokerage, you can choose from many different investment options — including CDs. This strategy is sometimes referred to as an IRA CD, although that’s simply a shorthand for an IRA that includes CDs. It’s not a special type of IRA (like traditional vs. Roth).
Why would you want to include CDs in an IRA? Investing in CDs within an IRA can add to your portfolio’s diversification. And unlike many other types of assets, CDs can offer a predictable rate of return.
IRAs themselves offer a tax advantage that applies to the interest earned on a CD. The money you invest (including interest payments) can grow taxed-deferred in the case of a traditional IRA — and tax free in the case of qualified withdrawals from a Roth IRA.
How a CD Works Inside an IRA
CDs within an IRA follow more or less the same rules as when you invest in CDs directly — with one big exception. Your deposit cannot exceed the annual IRA contribution limits. And if you’re funding a Roth IRA, you have to also meet the income requirements.
The cash in the CD is locked up for a set period of time. If you withdraw funds prior to the CD’s maturity date, you will face an early withdrawal penalty.
Once the CD matures within the IRA, you can either rollover the funds to another CD, or use the funds to purchase other investments.
CDs and Risk
One advantage of adding CDs to your IRA holdings is that CDs can be a low-risk component in your portfolio. Again, CDs generally provide a fixed rate of return for the duration of the CD.
Mutual funds, stocks, index funds — and many other assets that you might also hold within an IRA can be volatile, and there is a risk of losing money.
With some exceptions, many CDs offer some protection from loss, but no guarantees, thanks to the predictable rate of return and the fact that CDs are insured up to $250,000.
Pros and Cons of CDs
Before deciding whether CDs will suit your goals, here are a few points to keep in mind.
thumb_upPros:
• Many CDs offer a guaranteed rate of return which can be helpful for planning and income purposes.
• A CD generally has a lower risk of losing money, also it’s FDIC insured.
• When interest rates rise, CD rates can rise as well, which may make them more attractive as an investment in an IRA.
thumb_downCons:
• The money in a CD is locked up for a specified period of time (the maturity date).
• Withdrawing money from a CD before it matures could trigger a penalty and cost you some or all of the interest earned.
• When interest rates are low, CDs may seem less attractive as an investment for an IRA.
What Happens to Investments in an IRA?
One of the most common questions about IRAs is whether your money may grow over time. Considering the different types of potential investments within an IRA can help to answer that question.
• Investments such as stocks, bonds, mutual funds, and ETFs typically don’t offer a predictable rate of return, since the return on these securities depends on what’s happening in the markets. It’s possible that long-term market-based investments may offer potentially higher returns over time, but these asset classes generally come with a higher risk profile as well.
As a general rule, the higher the risk associated with an investment, the greater its return is likely to be. Lower risk usually equals lower rates of return.
• CDs interest rates are fixed, which offers an advantage when it comes to income planning. For example, if you plan to deposit $10,000 into a one-year CD that’s earning a 5.00% APY, it’s pretty easy to calculate how much money you’ll have at the end of the CD term (about $10,511, depending on the compounding schedule).
Your personal risk tolerance and timeline for saving can influence how you choose to invest in an IRA.
How to Think About Including a CD in Your IRA
Since IRAs are designed to offer tax advantages for retirement savings, you want to think long term when including CDs as investments in your IRA.
Given that a CD offers a predictable interest rate, a traditional IRA effectively allows you to defer paying taxes on the gains until you withdraw money in retirement. And a Roth IRA, if you qualify, allows you to take tax-free withdrawals, so the interest paid by the CD would become tax free.
The question then becomes whether you should open a traditional IRA or a Roth IRA.
Again, your ability to contribute to a Roth IRA depends on your income and filing status. If you earn too much money, then you may only be able to contribute to a traditional IRA.
A traditional IRA has its pros and cons, since you will likely be able to deduct your contributions, but you’ll have to pay income tax on the withdrawals later.
How CDs and IRAs Can Work Together
As discussed, you can use your IRA to invest only in CDs. But it’s also possible to contribute to an IRA — and separately fund one or more CD accounts to reach different goals. In fact, there are no restrictions on the number of CDs you can open, even if you have one or more IRAs.
Just remember that the annual IRA contribution limit applies across all IRA accounts, per person, whether you’re funding one IRA or four.
The Takeaway
There are many different accounts that savers can take advantage of: IRAs and CDs are two possible choices — and they can be combined, so that you can add CDs to your IRA holdings. This strategy can provide a tax benefit, as IRAs offer tax-deferred or tax-free growth, depending whether you’re investing in a traditional or Roth IRA, respectively.
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FAQ
Can a CD be used in an IRA?
Yes. Adding a CD to your IRA combines the features of a CD with the same rules, restrictions, and tax benefits of an IRA. You can save in CDs through an IRA if you’d like to earn a predictable rate of return for your money.
Is there a downside to an IRA?
An IRA is a tax-advantaged account, but it does not come with investments; you have to select investments within the IRA. Investing in CDs in an IRA is one way to add the predictable return of CDs to your retirement savings plan. It can also help balance other investments in your IRA that may be more volatile.
Are CD accounts worth it?
Investing in CDs can be worth it, whether you add them to an IRA — or buy a CD on its own. If you have a specific goal that you’re saving for, and you know that you won’t need the money right away, a CD can offer a predictable rate of return. When CD rates are high, you can also enjoy a decent return on your money. Comparing CD rates can help you find the best option.
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