IRA vs. CD: What’s the difference?
Key takeaways
- An IRA CD can help you earn a fixed annual percentage yield (APY) on retirement money.
- An IRA CD isn’t susceptible to market fluctuations.
- In addition to an early withdrawal penalty, there might be an additional 10 percent tax on withdrawals before you turn age 59 ½.
The individual retirement account (IRA) and the certificate of deposit (CD) are both tools for saving, but there are key differences between the two.
- An IRA is a retirement investing account that offers tax advantages. You can hold a range of investments in an IRA, including a CD.
- A CD is an account to which you deposit funds for a set period of time in exchange for a guaranteed rate of return.
What to know about IRAs
An IRA is an investment account with tax advantages that incentivize people to save for retirement. An IRA holds investments within it, so you don’t technically invest in an IRA. For example, an IRA can include stocks, bonds, exchange-traded funds (ETFs), CDs and more.
Types of IRAs
There are many types of IRAs, but the two most popular are the Roth and traditional. The differences between the two have to do with taxes. With a Roth IRA, you invest money you’ve already paid taxes on and can withdraw the contributions, including any earnings, tax-free in retirement. With a traditional IRA, you invest pre-tax money but will pay taxes when you withdraw the money in retirement. Traditional IRA withdrawals are taxed as ordinary income.
IRA contribution and income limits
Both traditional and Roth IRAs have contribution limits. The limit for IRAs in 2023, for example, is $6,500 per year. Those ages 50 and older are allowed to contribute an extra $1,000 in catch-up contributions, for a total limit of $7,500.
During the 2024 tax year (starting Jan. 1, 2024), the limit on annual IRA contributions will increase to $7,000 and those 50 or older can contribute an additional $1,000 during that tax year.
There are no income ceilings on traditional IRAs, so anyone can open one and contribute to it. There are income caps on Roth IRAs, however. Consult the IRS Roth IRA income table to see if you’re eligible to contribute to a Roth IRA and how much.
How to open an IRA
You must go through a bank or broker to open an IRA. IRAs are individually owned, so you can’t open a joint account with a spouse or child and, therefore, isn’t the right choice if you’re looking to open a retirement savings account with another person.
Rules on withdrawing money
With a traditional IRA, withdrawals taken before age 59 ½ incur a penalty. There are some exceptions, however, such as if you use the money on a first-time home purchase. Starting at age 72, withdrawals from a traditional IRA are mandatory.
Roth IRA withdrawals also are subject to a tax penalty if taken before age 59 ½, with some exceptions, such as using the funds to make a first-time home purchase or to pay college expenses. Also, there is a five-year wait period after your first account contribution before withdrawals are allowed. There are no required minimum distributions with a Roth IRA, however.
Pros and cons of IRAs
Pros
- If you don’t have access to a 401(k) through your employer, an IRA is a great way to save for retirement.
- IRAs have tax advantages.
- IRAs give you the flexibility to invest in an array of assets, such as stocks and bonds.
Cons
- Stocks in an IRA – for instance – are not insured by the Federal Deposit Insurance Corporation (FDIC).
- IRAs are for individuals only; you cannot open a joint account with another person.
- IRAs are meant for retirement savings, so there are tax penalties if you don’t follow withdrawal rules. For example, withdrawing money from a traditional IRA before age 59 ½ will cost you 10 percent of the amount you withdraw unless you use the money for a specific purpose, such as buying your first home. The penalty on early Roth withdrawals depends on how the money got in the IRA and how long it’s been there.
What to know about CDs
CDs are savings accounts that require the account holder to keep the money in the account for a set amount of time, called the term. They pay a fixed interest rate. At the end of the term, known as the maturity date, you have the option to withdraw the money from the CD. If you don’t withdraw the money, the CD may auto-renew, so be aware of the maturity date.
CDs typically offer higher yields than savings accounts but lower returns than riskier investments such as stocks. CDs are better for shorter-term savings goals (think a few months to three years) and those living on a fixed income. Meanwhile, riskier investments such as equities are better for longer-term savings goals that allow you to ride out any dips in value and benefit from higher long-term growth rates. You can hold these types of investments within an IRA.
Types of CDs
There are multiple types of CDs. The standard CD – in which you deposit a fixed amount of money for a set term (such as six months, one year or three years) and receive a fixed interest rate – is the most popular type. Other types include no-penalty CDs, bump-up CDs and IRA CDs.
CD deposit and income limits
Limits on how much you can save in a CD vary by financial institution. In addition, there are minimum deposit requirements of $10,000, $1,000, $500 or even $0, depending on the bank.
Some institutions offer jumbo CDs that require a minimum of $100,000. If you’re considering depositing a sizable amount, pay attention to deposit insurance. CDs that are held at FDIC-insured banks or National Credit Union Administration (NCUA)-insured credit unions are insured for up to $250,000, per depositor, per insured financial institution, for each account ownership category. Any money in the CD above that threshold, whether it’s the deposited money or the interest earned on the account, won’t be insured if the bank were to fail. If you’re in a position to save more than $250,000 in a CD, it’s advisable to spread around the funds in CDs at separately chartered financial institutions.
When you invest in a CD that’s within an IRA, either a Roth or traditional IRA, you’re limited to saving up to the IRA contribution limits mentioned above. There generally aren’t income limits on CDs. However, if you invest in a CD that’s within a Roth IRA, you will be subject to the Roth IRA income limits.
How to open a CD
CDs are available at banks, credit unions and brokerages. You can open an account at a bank or become a member of a credit union to open one of the institution’s CDs. At a brokerage, you may be able to open a CD just as you would at a bank. However, if you want to open a CD within an IRA, you must first open the IRA and then select the CD as an investment inside the IRA.
Rules on withdrawing money
You’ll more than likely pay a penalty fee if you withdraw the money before the end of the CD term. Penalties for early withdrawal can be stiff and can erode your earnings and maybe even your principal. Some financial institutions offer no-penalty CDs that let you access the money before the maturity date without any penalties, although rates tend to be lower than traditional CDs.With a traditional IRA CD, you’ll be taxed on your gains/earnings. And if you’re under 59 ½ at the time of this withdrawal you might have to pay an additional 10 percent tax.
Pros and cons of CDs
Pros
- CDs can be opened as a joint account with a spouse or child.
- CDs at FDIC banks and NCUA credit unions are federally insured up to $250,000.
- CDs are low-risk accounts that tend to pay higher interest rates than typical savings accounts.
Cons
- Most CDs charge a penalty for making early withdrawals.
- CDs haven’t historically earned as much as certain riskier investments, such as equities, over the long term.
- With a traditional IRA CD, you’ll pay taxes on the gain/earnings upon withdrawal.
- You’ll likely have to pay a 10 percent additional tax on distributions before you’re 59 ½.
Determine how IRAs and CDs fit into your financial plan
IRAs and CDs are very different financial products. You don’t necessarily have to pick one or the other; both accounts may be beneficial for you.
For example, you could contribute to a Roth IRA that holds an ETF with the purpose of building long-term wealth to fund your retirement. At the same time, you could open a three-year regular CD to earn interest on money earmarked for a down payment on a home.
Deciding whether to open an IRA or CD, or both, depends on your financial goals. Leverage the tax advantages of IRAs to save for retirement. Consider a CD when you have a short-term savings goal and want to protect your principal.
Bottom line
IRA CDs can be a way to earn a fixed APY. And they can have the safety of FDIC or NCUA insurance, as long as your balance is within the insurer’s limits and guidelines. With a traditional IRA, for example, you may be eligible to take a full deduction depending on your income and whether you’re covered by a workplace retirement plan.
— Bankrate’s Matthew Goldberg contributed to updating this story. Amanda Push wrote a previous version of this story.
