What’s So Special About an IRA CD?

One of the products gaining in popularity right now is the IRA CD. As some savers become wary of the stock market, they are turning to cash products that might provide a little more safety and security. Banks, credit unions and other financial institutions can market CDs as being especially appropriate for IRAs, but the truth is that an IRA CD really isn’t so special; it’s just a CD that financial institutions market as being ideal for inclusion in an IRA.

What Can You Put Into an IRA?

First of all, it is important to realize what an IRA is. An Individual Retirement Account is not an investment itself. It is an investment account. You can use your money to purchase different investments, which are held in your IRA. An IRA comes with tax advantages, and is meant to help provide you with income during retirement. You can use the money in your IRA to invest in almost anything you would like from stocks to funds to bonds to real estate. You can also use the money in your IRA to invest in CDs. However, you can invest that money into any CD you would like. It does not have to be a “special” IRA CD in order to be held in your retirement account.

What is an IRA CD?

In reality, IRA CDs are just plain old CDs. Financial institutions might label them as “IRA CDs”, but they have the same characteristics as other CDs. You agree to let the financial institution use your money however it would like for a set period of time. Early withdrawal penalties apply. (With CDs held in your IRA taking that money out of your IRA as part of your withdrawal can trigger penalties related to your retirement account.) Because the institution is using your money, you are paid interest. There are CDs with variable rates, but most CDs come with fixed yields.

Some financial institutions do try to make IRA CDs more attractive by offering higher yields, especially since many CDs marketed as good choices for an IRA have longer terms, usually between three and seven years. There are IRA CDs that have terms as long as 10 years. Many minimum deposits vary from $500 to $10,000, although you can almost always find CDs that allow you to put in more or less. As with any other CD, you are more likely to get higher yields with an IRA CD that has a longer term and a higher deposit.

When your IRA CD matures, the financial institution may automatically renew the CD, putting your money into a new CD of the same maturity at the prevailing interest rate, or the same rate as before. Make sure you understand what your bank will do if you do not direct that the money from your mature IRA CD be used elsewhere. Many financial institutions will notify you seven to 14 days before a CD matures, so that you can decide what you want done with your money. You can put the money from a mature CD into another investment in your IRA, but, unless you meet eligibility requirements for withdrawal from your IRA, you cannot take the money out of your retirement account. You can use the money to purchase bonds to be held in your IRA, or into stocks, or into any number of other investments in your IRA. You can even hold the money in an IRA savings account while you figure out what to do with it.

Whether or not you get a CD labeled as “IRA”, you will receive tax advantages by putting a CD in an IRA. With a traditional IRA, your contribution to the account is tax deductible, lowering your taxable income. If you have a Roth IRA, you won’t get a tax deduction, but your earnings from the CD will be tax free, as long as you follow the rules involved in withdrawal. Additionally, a CD that you put into your IRA is usually protected by FDIC insurance. This means your CD is insured for up to $250,000. (Double check to make sure you get your CD from an FDIC-insured institution.) Knowing that a portion of your IRA is FDIC-insured can provide comfort for those looking for a little more security in a retirement portfolio.

Choosing a CD for your IRA

Before you decide to put your money into an IRA CD, it is a good idea to consider your options. Realize that you do not need a CD to open an IRA. Also, you can put any CD you want into an IRA; it does not need a special label.

When deciding on a CD to put into your IRA, you should compare CDs marketed as ideal for IRAs with other CD options. Compare CD rates from a number of sources to determine what will work best for your situation. In some cases, financial institutions do offer IRA CDs with better terms than many of their “regular” CDs. In some cases, though, you might be better off simply getting a “regular” CD and holding it in your IRA.

Understand, though, that a CD in your IRA is not going to offer great returns. Like most cash products, the low risk associated with a CD means that the yields are going to be low as well. You will probably get a better return than you would with a high yield savings account, but you will still be getting a fairly low yield. Having a portion of your retirement account in cash products like CDs can add security, but you are unlikely to build wealth fast enough to meet your retirement goals if the only holdings in your IRA are CDs.

Another risk you run with adding CDs to your IRA is missing out on higher yields down the road. If you get a seven year IRA CD at 3.49% (Pentagon Federal Credit Union), and interest rates head higher during those seven years, you could be missing out on the possibility of higher yields. It is possible to build a CD ladder within your IRA, using shorter-term CDs so that you have the option of putting the money elsewhere as the CDs mature.

Bottom line: An IRA CD can be a helpful part of your retirement portfolio, depending on your situation. However, you can put any CD in your IRA; it does not need to be designated as an “IRA” CD.