If you’re saving for retirement, you may be investing already in an individual retirement account, or IRA. You may have a traditional IRA or a Roth IRA, both of which are accounts that are focused on investing for the long term.
Yet as retirement starts to come closer, you may want to take some of your earnings from the stock and bond markets and place them somewhere less risky. Or maybe retirement isn’t as near, but you want to take a break from the market’s roller coaster. But you also want that money to earn interest in the meanwhile.
That’s where an IRA CD can come in handy. If you haven’t heard of it before, it’s a certificate of deposit that you hold inside of an IRA. The way a CD works is that it offers you a fixed interest rate over a fixed period of time, usually between three months and five years. Your bank will usually offer higher interest rates if you agree to keep your money in the CD for longer amounts of time, though you may be subject to a penalty if you take it out before that time span expires. Here’s what you need to know.
Are You Missing Out on an IRA CD?
By keeping your IRA assets in a CD, you get a few advantages. The first is higher interest rates than you’d get in most savings accounts. The second is that your money is FDIC insured up to $250,000 per depositor, per insured bank, for each ownership category.
With interest rates in flux, one nice thing about a CD is that you can lock in an interest rate today, and you’ll be able to know your returns over the coming months and years to the penny, with absolute certainty. That can be a big help in planning for expenses in retirement.
The IRA part of the CD offers its own advantages. For one thing, you can take a tax deduction on the personal income you place into a traditional IRA. You can also roll over funds from a 401(k) or other IRA into an IRA CD, just like other IRA investments.
There are other tax benefits to placing your money in an IRA CD. But those benefits depend on whether you place your money into a traditional or a Roth IRA.
CDs in a Traditional IRA vs. a Roth IRA
When it comes to choosing a traditional IRA or a Roth IRA, the choice comes down to when you want to reduce your taxes.
If you want to pay less in taxes this year, then a traditional IRA is likely the way to go. In a traditional IRA, you can take a deduction on your income taxes for the money you contribute that year. You will, however, have to pay income taxes on withdrawals, including interest, in retirement.
But if you’re concerned about the income taxes you’ll pay in retirement, then a Roth IRA may be a better choice. Roth contributions come from your post-tax income, but withdrawals—including any interest that has accrued in the account—is income-tax free.
No matter which IRA you choose, remember that this is money you’re likely saving for the future, because they each come with tax penalties if you withdraw your money before you reach age 59½.
You should also consider required minimum distributions, or RMDs. Traditional IRAs require that you withdraw a certain amount of money and pay taxes on it, after you reach a certain age. Roth IRAs, on the other hand, do not.
To find out more about how IRAs work, check out this article.
All About Lower Risk
While most people saving for retirement will start heavily invested in stocks, those investments carry risk. If you are decades away from retiring, then an IRA CD may not offer the long-term growth you’re looking for.
But as time goes on, most experts recommend a gradual shift to less-risky assets. And CDs can provide you with guaranteed returns on your principal, along with FDIC insurance.
In an IRA CD, you can find modest, predictable growth for a portion of your portfolio. And if interest rates are rising, you can even take advantage of those increases with a bump-up CD, which allows you to request a higher interest rate on your CD if the rate offered for your CD rises. You usually are allowed only one rate increase during the term of your CD.
Consider the Rates
Because CDs come with a fixed holding period, it’s important to do your homework before you invest. Look at the rates offered by CDs of different durations and see how those time frames fit into your plans. And then see how the interest rates of those CDs could help you in retirement.
Our “Are you on track for retirement?” checklist can help you to see how your money will grow over time in an IRA and show exactly how much more you can earn by keeping your money in a CD for a longer period.
And shop around for the best rates on your IRA CD; check online periodically for rates, as they do change. Often, digital banks can offer higher rates, because they don’t have the legacy brick-and-mortar infrastructure to support.
While IRA CDs may not be ideal for every step of your retirement planning, they can play a very important role as a low-risk, high yield option.
Colin Dodds has written for preeminent media, technology and financial companies. He is the author of several acclaimed books, including Pharoni and Ms. Never. He lives in New York City with his wife and children.
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