Notes on Personal CD Investing: IRAs - Part 1
As the readers of DepositAccounts.com know, rate chasing is a great way to maximize the interest you earn from CDs. However, rate chasing has complications, and that’s especially the case for CDs held inside IRAs. A long-time reader and friend of the site, Charles Rechlin, has graciously offered to share his experience in CD investing inside IRAs. Charles has many years of experience with multiple IRA CDs at banks, credit unions, and brokerage firms. I’m very thankful that Charles was willing to share his experience in two guest posts. Part one is below. Part two will be published next week. Update: Part two has now been published and is available here.
Notes on Personal CD Investing: IRAs - Part 1
by Charles Rechlin
Like many seniors who follow this site, I have a meaningful individual retirement account (IRA) nest-egg, accumulated over many years.
Being risk-averse, I’ve invested pretty much all my IRA assets in federally-insured certificates of deposit. About half are in traditional IRA CDs established directly with banks and credit unions (direct CDs); the other half in CDs held in traditional IRA accounts at online brokerage firms (brokered CDs).
As with most things financial, I’ve found both advantages and disadvantages in each type of CD investment. However, as time has passed, and managing my IRA portfolio has become more complicated, I’ve increasingly steered my IRA assets away from direct CDs and into brokered CDs.
Direct IRA CDs
Because IRS rules permit taxpayers to have more than one traditional IRA, I’ve been able to invest my IRA assets in direct CDs at multiple banks and credit unions.
My IRA CDs have included nationally-available accounts at online banks such as Ally, CIT and Synchrony, and accounts at local brick-and-mortar banks such as Rabobank and First Republic. IRA CDs at credit unions have included those of giants PenFed and Alliant (nationally-available) as well as tiny, Riverside, CA-based RAFE Federal.
Direct IRA CDs have a number of attractions for me, in addition to the obvious one of up to $250,000 in FDIC or NCUA deposit insurance separate from the insurance on my other accounts.
First, at most banks and credit unions that offer them, IRA CDs usually pay the same rates as those posted for standard CDs of identical maturities. So, if the bank’s or credit union’s regular CD rates are competitive, its IRA CD rates are as well.
Often, but not always, IRA CDs are included in special CD rate promotions. And sometimes, institutions will offer a premium rate on IRA CDs not available for standard CDs.
Because paid interest can be added back to principal, IRA CDs also permit compounding at the rate borne by my CD, without incurring current taxes on that interest.
Moreover, although direct IRA CDs, like standard CDs, generally impose restrictions on, and penalties for, early withdrawals, many banks and credit unions have a special exception permitting early withdrawals, without penalty, to allow meeting annual required minimum distribution (RMD) obligations after age 70-1/2.
Of course, IRA CD terms vary from institution to institution. And some banks and credit unions charge maintenance and other fees to IRA CD customers. Thus, I’ve had to pay close attention to the fine print of account documentation, Truth in Savings Act disclosures and fee schedules.
To my mind, the major downside of direct IRA CDs is the cumbersome nature of opening and closing accounts. More often than not, when an IRA CD matures at an institution, the renewal rates posted at that institution can be improved upon, sometimes significantly, by moving the funds into a CD at another institution.
This requires a full-blown transfer, and that’s where the problem lies, particularly with so-called "trustee-to-trustee" transfers.
Although some online banks have simplified the process to a degree, a trustee-to-trustee transfer remains mired in pre-Internet-era hard-copy paperwork and snail mail requirements that are time-consuming and prone to error, including funds transfers by check rather than electronic means.
A trustee-to-trustee transfer can also take many weeks to complete, even if done correctly. Almost always, unless an IRA savings or money market account can be established at the existing institution, transfer requests must be initiated well in advance of an IRA CD’s maturity date to avoid the running of the renewal grace period.
Because of the built-in delay in moving funds, IRA CDs aren’t ideal instruments for "rate-chasers" like me. Many banks and credit unions won’t honor a posted CD rate during the prolonged transfer period, reserving the right to change it up to the moment the old bank’s check arrives.
Some top-tier online banks, however, show sympathy for the plight of the IRA customer by locking in the rate for a limited period. For example, Ally expressly gives you 90 days to finish the process. CIT informally offers 60 days.
I recently experimented with bypassing the trustee-to-trustee transfer process by engaging in a "rollover" transfer—i.e., taking an otherwise taxable distribution out of the balance of a maturing CD at one institution and then reinvesting it in a new IRA CD account at another within 60 days, thereby avoiding taxes on the distributed funds.
Although the rollover transfer proved much more efficient than the normal trustee-to-trustee transfer, the IRS limits you to only one rollover every 12 months from all your IRA accounts. Trustee-to-trustee transfers are not limited.
Because of the time, effort and risk involved in opening and closing IRA CDs, I’ve increasingly moved funds from maturing CDs to my IRA accounts at online broker-dealers Fidelity Investments and Vanguard Brokerage. I then invest those funds in brokered CDs, as I will describe in Part 2.
"I hate, hate, hate trustee to trustee transfers. They are a pain in the ****, but with the new rules for rollovers there is really no alternative."
"It's important to note that the rule doesn't apply to trustee-to-trustee transfers, the type of transfer that is done between brokerages. If a check is involved, it will be made payable to the brokerage or bank, for benefit of the client's account, but the client won't access the funds. "You can do those all day long. You can do 15 a day if you wanted," Slott says."
One thing to remember with a rollover transfer is that the "from" institution will issue a tax form at year end coded in a way which identifies the amount of the rollover transfer as a taxable distribution. When you file your income tax return for that period, if you have completed the transfer by the 60th calendar day after the day you receive the distribution from your IRA, you must be careful to document that it is therefore NOT a taxable distribution. In addition to completing line 15, parts a and b on Form 1040 appropriately, I also include a note with my return explaining the timing of the transactions involved to show that the 60-day window was met.
I learned to do that after being audited one year because the IRS thought I had failed to report a significant amount of income. My first thought on receiving the notification was that someone must have fraudulently used my SSN. However, the amount had a familiar ring. When I reviewed my files, realized that it coincided with the amount of an IRA rollover. I confirmed that Form 1040, line 15 had been completed correctly according to the instructions, but apparently not to someone's satisfaction.
Fortunately I keep careful records and composed a letter explaining why it was not taxable income. Attaching copies of the actual documents I submitted requesting the transfer, a copy of the check made payable to me, and a copy of the overnight receipt showing delivery at the receiving institution within the appropriate time frame laid it all out clearly and the audit was closed promptly.
This event did not dissuade me from doing other rollovers, only reminded me to be careful with the details so that I could prove everything had been done correctly.
BTW--I'm responding as "Anonymous" (I think) until Ken and I can change my screen name to "CharleyR" from "OldGuy" (the name I've haunted this site with in the past).
I have several IRA CDs maturing over the next three years, with the first one in a couple of months. 90% are with an institution that in the past has moved slower than molasses in January. They had wonderful rates several years ago - although unfortunately not any longer. So, in order to get the best rates I may have to resort to moving the money myself. Of course, since some mature within six months of one another, there will be an added complication : keeping a careful eye on the calendar in order to avoid running afoul of the new "once every 12 months" rule.
Realistically, most may end up moving as trustee-to-trustee transfers. I'll hope for the best and cross my fingers that the receiving institution will hold open whatever rate I find.
Old Guy/Charley R; always enjoy your posts, regardless of what name you use.
I know you haven't written the broker IRA cd section yet, but please be careful about the FDIC insurance limits on broker CDs. You must be sure which banks you get these cds in so as to not overlap with your privately held IRA cd banks.
I converted mine to Roth IRA years ago and could not be happier for doing that.
People need more education on how to avoid high taxes, I guess.
While your statement about annuities is true, that's the same as for CDs. The interest is taxable when withdrawn. If you put $100K in an IRA CD 30 years ago and it's grown to 300K, then a third of each withdrawal is return of principal. If you took a deduction when you put that $100K into the IRA, your entire withdrawal is taxed. If you had made non-deductible contributions, the $100K would be return of principal and so only 2/3 of each withdrawal would be taxable. Again, that's not specific to CDs, it's just how IRAs work. Even if you had bought annuities in your IRA, anything you contributed pretax is taxable when withdrawn, and earnings are always taxable when withdrawn. Keep in mind that IRAs are not a tax avoidance tool, but a tax deferral tool.
If you're able to support yourself with other retirement funds and just take RMDs, it's probably not a big concern. But if you're withdrawing the majority of your living expenses from an IRA, that's going to generate taxable income no matter what you invested the money in. #7's friend got a tax benefit when he put the money into the IRAs and now it's time to pay the piper. Alterrnatively, he could have paid the taxes along the way and not be taxed now. Remember, TANSTAAFL.
read whatever thoughts you have on rmds.
"Because of the time, effort and risk involved in opening and closing IRA CDs, I’ve increasing moved funds from maturing CDs to my IRA accounts at online broker-dealers Fidelity Investments and Vanguard Brokerage."
Before the crash, I used to have everything in Fidelity's CD's. Since I was still working at that time, I didn't have a lot of time to go rate chasing. And, my buddies at Fidelity had pretty competitive rates back then. After the crash, their rates stank (and still do). Since my wife wasn't working, I had her do the rate chasing for me. She yanked everything out of Fidelity and found better IRA CD rates at online banks.
Now that I'm retired, she's wised-up and dumped the IRA CD rate chasing back on me. I've moved most all of the IRA CD's to credit unions. This is mostly because they give higher rates. But also because I hate banks. I don't think that the clowns that crashed the economy deserve my money. I've also moved some money into about 10% into TIPS. I'd move more but with inflation low and the bond prices sky high, it's just not the right time to do this.
The main disadvantage that I have with brokered CD's from Fidelity or Vanguard is that if you need the money before they mature you're stuck with selling them on the secondary market. This means that you can lose principle if interest rates ever do start going up in a meaningful way. There's other CD brokers out there. But, I've never found one that could offer better rates than I can find on the internet (especially this site). So, I find zero upside to these CD's.
As you have pointed-out, the main disadvantages to non-brokered IRA CD's is the tedious IRA transfer paperwork and the amount of time it takes to get the new IRA funded. If an institution requires the documents to be mailed, this can take a couple of weeks. In the meantime, that CD rate your chasing may expire.
About the only way to get around that conundrum is to deposit the IRA funds into an IRA savings account. Then if the CD rate your chasing is still available on the day that the IRA funds are received, you can simply open an IRA CD by transferring the funds from the savings account to the CD. These internal transfers are done the same day and therefore guarantee that you'll be getting the rate you were chasing.
So far, I've never had to deal with the situation where the CD rate is no longer available. But, at least this approach gives you the option of avoiding being locked into a lower CD rate than the one chased. Or, having to face an early withdrawl penalty if the new rate is totally unacceptable.
If I was still working I doubt if I'd be doing this. So far this year, I've had an IRA transfer check and paperwork go missing. I've also seen CD rates disappear 16 days into the promotion. Since that one was not an IRA, I was able to get it funded on the very last day that it was available.
But, I'm retired now. So, this is my new hobby. Also, I've managed to keep my average CD term under 5 years with with average rates over 2.0%. In a way it's pretty comical. When I was in grammar school some 60 years ago, I was getting 5% on a passbook rate.
I have a feeling you and I have a lot in common vis-à-vis CD investing. Actually, I handle my taxable portfolio--which is significantly larger than my IRA portfolio--basically the way you handle your IRA portfolio. Each and every dollar is invested in a direct CD at some bank or credit union. No brokered CDs at all. Since I pay the bills out of the income from my taxable portfolio, I'm much more sensitive about getting the highest rate. Your 2% average yield for an average maturity of something less than five years is identical to the results I've gotten. I also get a kick out of managing a taxable portfolio of direct CDs--it's fun.
Managing a portfolio of direct IRA CDs is--for me--no fun at all, for the reasons stated in Part 1.
But if we all did the same thing, I suppose we'd have nothing to write and talk about.
Mostly its done really well in stocks but I have a large chunk of it earning next to nothing right now.(About 24%)
Im more interested in investing that than buying CDs with it.
When you're retired you probably don't have the ability to recover from losses incurred by investing in risky investments. The older you get, you may not even have time to wait for the market to recover from a downturn. You might be dead by then.
Also, I'm alway amused with "professional financial advisors" that use your "risk tolerance" as a measure of the degree of risk that you should take. What they should be measuring is your capacity for risk. Which is really a nice way of saying your capacity to recover from a loss.
If you're young, you have a lot of time to recover from a loss. If you're rich, you probably don't even have to recover from a loss. If you're not either of the two, you need to think hard and long about investing hard-earned cash into risk asset classes.
Since there's such a huge psychological component to capitalist markets, I've steered clear of them. If I can't quantify risk, I really don't want anything to do with it. This has definitely prevented me from realizing potential gains. However, it has protected me from potential losses. I've alway been happy just to to keep up with inflation.
We're nearly ten years into the latest financial fiasco of the US led capitalist system. Even though the original recession officially ended back in 2009, it's affects are still being felt worldwide. If you look back upon the last ten years, it's almost unbelievable what happened. Worse yet, it's truly scary to think about what almost happened.
I'll stick with my CD's, thank you.