Tax Implications for Transferring an IRA CD to a Regular CD

by Craig Woodman

Many conservative investors hold funds from their individual retirement arrangement accounts in a certificate of deposit with a bank. A CD has a potentially lower rate of return then other investments, but a CD's rate is guaranteed, and the principal is insured against loss for up to $250,000 as of publication. If a CD owner chooses to convert his IRA to a regular CD, he could face tax implications depending on the type of account.

Taxable Income

An account owner who transfers a CD held in a traditional IRA account to a regular, non-retirement CD will increase his taxable income for the year. The entire value of the CD will be added to the account owner's taxable income when converted, and he will have to pay taxes on that money at his normal income tax rate. The sudden influx of income could cause him to move to a higher tax bracket for the year, increasing the amount of taxes that he must pay on the conversion.

Early Withdrawal Penalty

In addition to the income tax, the owner of the CD could also face a tax penalty from the IRS. If the taxpayer is less than 59-1/2 years old, the transferred CD will be considered an early withdrawal. The IRS will levy an additional 10-percent penalty to any taxes due for this conversion. The penalty will apply to the entire value of the CD if transferred, unless it is due to the death or disability of the account owner.

Roth IRA

Due to the after-tax nature of Roth IRA contributions, if the CD is held in a Roth account, it will be treated differently. Roth IRA contributions can be withdrawn tax-free at any time. In addition, tax penalties do not apply to withdrawals of Roth contributions. The earnings from the Roth account will be subject to taxes and penalties like a traditional IRA, unless the owner is 59-1/2, and has had the account open for at least five years. In that case, no taxes or penalties would apply to the earnings withdrawal.

Other Options

If the account owner needs the interest income from the CD for living expenses, he can move the IRA CD to an IRA money market mutual fund. He can withdraw the interest from a money market fund, protecting the remaining balance from taxes and penalties. The withdrawals would be taxable according to the rules for the type of IRA. Another advantage is greater liquidity, because he can take withdrawals from a money market mutual fund at any time, without facing a penalty from the bank for early withdrawal. The principal balance of a money market fund is not insured, and the rate of return may fluctuate.

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