IRA CD Definition

by Cam Merritt

An "IRA CD" is simply a certificate of deposit held in an individual retirement account. Though some banks may offer CDs with features that make them easier to incorporate into a retirement-planning portfolio, most CDs marketed as IRA CDs won't be much different from the certificates of deposit offered to other customers.

IRAs

Individual retirement accounts allow you to invest money for retirement while deferring many income taxes until later. With a traditional IRA, you don't have to pay income taxes on the money you put into the account. Nor do you have to pay taxes on the profits you make from investments within the account. When you start taking "distributions" -- that is, withdrawals -- after age 59 1/2, you pay regular income taxes only on the money you take out. A variation, the Roth IRA, lets you make contributions with "after-tax" dollars, or money that you've already paid income tax on. Your investment profits aren't taxed, and under most circumstances you don't pay taxes on your withdrawals after age 59 1/2.

Putting CDs in an IRA

An IRA is an account that holds your investments, not an investment in itself. As a result, you can invest in a wide variety of things within the IRA. Stocks, bonds and mutual funds are common. Depending on how the IRA is structured, the IRA can be used to hold precious metals or even trade in foreign currencies. Certificates of deposit are especially popular with people looking for a low-risk place to park IRA money. A CD is a time deposit: You give money to a bank, and, in exchange for promising to keep the money there for a certain length of time, you receive interest. If you cash in the CD before it matures, you pay a penalty. The longer you commit to keeping money in the CD, the higher the interest. Bank CDs in an IRA won't produce spectacular returns, but they're safe -- typically insured by the federal government -- and they provide steady income, features that are especially attractive to people getting closer to retirement.

IRA-Friendly Features

There's often nothing special about a certificate of deposit marketed as an "IRA CD." They usually work the same way as other CDs. However, some banks have devised CDs with IRA-friendly features -- in particular, the ability to convert part of the CD to cash without penalty in certain circumstances. Once IRA owners reach age 70 1/2, they typically must begin taking a certain amount of money out of their accounts (and paying taxes on that money). The minimum amount they have to withdraw is based on the balance of the account and the account-holder's age. Some IRA-oriented CDs allow account holders to redeem a portion of a CD before maturity penalty-free so that they have the cash to make this "required minimum distribution." Other IRA-oriented CDs may have customizable deposit terms, so that account holders can arrange for CDs to mature "just in time."

Laddering

When holding CDs in an IRA, especially as you get closer to having to take required minimum distributions, it may be wise to "ladder" your CDs. Rather than have, say, $100,000 locked up in a single five-year CD, you could put $20,000 each into separate five-year CDs that mature a year apart from one another, so that each year you have the option of cashing in one $20,000 CD in if you need the money for distributions or other expenses. If you don't need the cash in any year, you can simply "roll over" that year's CD into another five-year CD.

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