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.