What Is an IRA CD?

Quick Answer

An IRA CD combines the stability and relatively high yield of a certificate of deposit (CD) savings account with the tax benefits of an IRA. Retirement savers who want reliable savings and predictable income may be willing to trade the potential upsides of growth investing for the modest gains of an IRA CD.

Asian couple planning their retirement at home.

Retirement investors who want to add stability while taking advantage of rising interest rates on savings might consider adding IRA CDs to their retirement mix. An IRA CD is a savings account that earns fixed interest over a predetermined period of time. IRA CDs offer the tax advantages of IRAs with the safety and stability of a savings account, though they also have significant limitations you should consider. To learn more, read on.

How Do IRA CDs Work?

IRA CDs combine the low risk and relatively high interest of a certificate of deposit (CD) with the tax benefits of an individual retirement account (IRA). If you're concerned about volatility in the markets, an IRA CD might be for you.

What Is an IRA?

An IRA is a tax-advantaged account designed to help you save for retirement. There are two main types of IRAs, traditional and Roth:

  • A traditional IRA lets you earn money on retirement savings tax-deferred. Your capital gains and interest earnings aren't taxed for as long as they stay in your IRA. Traditional IRA contributions are tax-deductible, but you'll pay income taxes on your withdrawals when you retire.
  • A Roth IRA lets you earn money on retirement savings tax-free: You never pay taxes on capital gains and earnings in your Roth IRA, as long as you make qualified withdrawals. Roth IRA contributions are not tax-deductible, but you don't pay income taxes on your withdrawals when you retire.

Both types of IRAs are designed for saving over the long haul. So, even though there are exceptions that allow you to withdraw your IRA funds early to pay for a home purchase or college, for example, IRAs are not a good place to store ready cash.

What Is a CD?

A CD is a type of savings account that pays a fixed amount of interest over a set period of time. Say you deposit $10,000 into an 18-month CD that pays 3.89% interest. If you leave your money in your account for the full 18 months, you will have $10,589 when the CD matures. When your term ends, you'll need to roll your money into a new CD or other investment.

Rates on CDs vary from one financial institution to another, so it's worth shopping around. CDs with longer terms generally pay higher interest rates: A 5-year CD normally beats a 12-month CD, for example. A bump-up CD lets you request a rate increase at least once during your term. Taking your money out before a CD matures means paying a penalty, usually equal to weeks or months of forfeited interest. A liquid or no-penalty CD allows you to withdraw your money early without a penalty.

What Is an IRA CD?

Simply put, an IRA CD is a CD that is invested for retirement. You can fund an IRA CD by contributing new funds or rolling over funds from an existing IRA. If you're opening an IRA CD with new funds, the IRS limits your contribution to $6,000 in 2022 and $6,500 in 2023, with an additional catch-up contribution of $1,000 if you are age 50 or older. If you're rolling over funds from an existing IRA, these contribution limits don't apply.

Pros and Cons of IRA CDs

IRA CDs have significant pros and cons. Whether an IRA CD is the right choice for your retirement portfolio depends on your priorities and, to some extent, how close you are to retirement.

Benefits of IRA CDs

The primary benefit of IRA CDs is stability. Your account value will not fluctuate and your interest earnings are completely transparent. If you are retired or nearing retirement, this stability can be reassuring—and may save you from having your account value plummet just as you're hoping to use it for reliable income. Consider an IRA CD if you want the following benefits:

  • Predictable income: A CD is a stable asset. You know upfront how much interest you'll earn and for how long.
  • Safety from loss: Your money doesn't lose value in a CD. By contrast, the value of growth assets like stocks and exchange-traded funds (ETFs) can rise and fall with the market. You may see greater returns on growth investments, but you may also experience losses.
  • FDIC insurance: IRA CDs from banks or credit unions (and some brokerage houses) are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Association (NCUA).
  • High interest compared with regular savings: To get an idea of how advantageous CD rates may be compared with regular savings accounts, consider how interest rates stacked up on a typical day in late 2022: 4.5% on a 5-year CD; 3.75% on high-yield savings; 1.15% on regular savings accounts.
  • Additional stability: Keeping a portion of your retirement portfolio in an IRA CD earning fixed interest for a few years can help balance out risk. Consider a CD ladder to create predictable income over time.

Drawbacks of IRA CDs

With an IRA CD, you trade growth for stability. If you have years or decades to go before retirement, you may want to focus on growth-oriented investments to maximize your funds. Even if you're nearing retirement, you may want to maintain diversified investments that include CDs rather than moving all of your money into IRA CDs. The primary drawbacks of investing in IRA CDs are:

  • Limited returns: Historically, growth investments like stocks or mutual funds show greater returns than CDs. Higher returns can have an exponential impact on retirement savings over time.
  • IRA contribution limits: Although you can invest existing IRA funds in CDs to avoid contribution limits, new contributions are limited by the IRS.
  • Active scheduling: You can usually set up your IRA CDs to roll over automatically after they mature, but it's a good idea to manage your CDs actively. Use the window between one CD maturing and the next one opening to check interest rates, add funds or move your money to a different investment. To be effective, you'll need to track your CDs periodically and be prepared to make changes if market factors change.
  • Potential penalties: You could be penalized twice if you withdraw money early from your IRA CD. Here's how: Say you put $10,000 into a 3-year IRA CD in January. In October, your roof springs a leak and you need $6,000 for emergency repairs. Unless you're 59½ or older, you could pay a 10% early withdrawal penalty and regular income tax on your $6,000 withdrawal. Additionally, you could forfeit interest on your IRA for taking the money out before your CD matures.

How to Open an IRA CD

You can find IRA CDs at almost any bank, credit union or brokerage company. At a credit union, a CD may be called a share certificate. You have two main choices for investing in an IRA CD:

  • Contribute to a new IRA CD. Shop around for the best rates, then deposit funds to open a new account.
  • Roll over funds from your existing IRA. Fund your IRA CD with money from your existing IRA by completing an IRA-to-IRA rollover. Follow the rules for IRA rollovers to avoid an early withdrawal penalty from the IRS.

Alternatively, you may be able to invest in CDs within your retirement portfolio. Check with your investment company or financial advisor to see if you can hold CDs in your existing retirement account and what your options are for doing so. Your advisor can also help you decide whether CDs make sense for your investment goals and how much of your portfolio you might want to devote to them.

The Bottom Line

IRA CDs are an investment alternative for retirement savers who want more stability and less stress. Even in a relatively high interest rate environment, IRA CDs aren't aggressive growth investments. But rising interest rates can make high-yield savings vehicles like these more attractive, especially for savers who are nearing retirement.