An Individual Retirement Account, referred to as an IRA, offers tax advantages to help you save for retirement. An IRA acts like a basket to hold different types of investments and assets. One of the investment options you can hold in an IRA is a Certificate of Deposit. A CD is a timed-savings account that offers a set interest rate for a specific period.
If you have a Traditional IRA, any contributions to the account are tax deductible. The amount you invest in your IRA CD lowers your taxable income. If you have a Roth IRA, there isn't a tax deduction for your contribution, but the interest earned on the CD grows tax-free, provided you wait until retirement age to begin making withdrawals.
Both traditional CDs and IRA CDs have Federal Deposit Insurance Corporation coverage of up to $250,000. Coverage for each account holder is per bank, not per account. For example, if you have a $200,000 CD and $100,000 in a checking account at the same bank, $50,000 is uninsured.
Withdrawals and Penalties
Like traditional CDs, early withdrawal penalties apply if you withdraw funds before the IRA CD matures. The penalties vary depending on the bank and duration of the CD. If you're under age 59 1/2 and make an early withdrawal, you'll also face the Internal Revenue Service's 10 percent tax penalty if you don't transfer the money to another IRA. If you have a traditional IRA CD, you'll pay income taxes on the distribution amount. If it's a Roth IRA CD, you'll pay income taxes on the interest earnings if you take a withdrawal before age 59 1/2.
Pros and Cons
An IRA CD offers reliability and predictability. Unlike other investment options within an IRA, such as stocks, you know exactly what you're going to earn. IRA CDs also eliminate many of the costs associated with other retirement investments, including brokerage commission and asset management fees.
However, although CDs are reliable and stable, the growth is generally slower than other investment options. CDs are also vulnerable to inflation. Since IRA CDs terms are generally for several years, you're locked in to that rate even if interest rates rise.