Q: Are there any tax consequences if I transfer money out of a money market fund or a money market account and into a long term CD?
A: This should be no problem, assuming the money is in an ordinary taxable account. If it is in a tax-advantaged vehicle like an individual retirement account (IRA), make sure the certificate of deposit (CD) is also within the IRA, or rolled into another IRA.
Interest held in a money market account is taxable in the year in which it is earned. So if you close the account, just remember that you will have to include any interest earned so far this year on your 2016 tax return.
As you contemplate the switch from a money market account to a CD, take some time to think about how to make this move fit with your eventual financial goals for the money.
How to evaluate financial needs and tax status for CDs
The first thing to think about is whether you are saving this money for some particular upcoming need, or generally for retirement. If there is a specific need on the horizon, that will help determine what length your CD should be, whether a long term CD or a short term CD.
If you are shifting this money into a long term CD because you are saving for retirement, you might consider shifting it into a Roth IRA. Assuming this is currently a taxable account, putting the money in a Roth IRA won't provide any tax advantage in terms of the principal you deposit. However, it will allow the account to earn interest tax-free until you withdraw money from it. Be advised, though, that there are income restrictions and contributions limits that determine whether and how much you can contribute to a Roth IRA.
What to look for in a CD
Whether or not you move the money into an IRA, identifying the purpose of this money will help guide your search for the right CD.
Here are four things to consider as you make that search:
If you have an upcoming need for the money, that may determine the length your CD should be. Otherwise, since CD rates are generally higher on longer deposits, longer is better unless you think a rise in interest rates is imminent.
2. Laddering opportunities
If you have a series of different needs or want to hedge against interest rate changes, you might want to consider a CD ladder, which is a sequence of CDs with different maturity dates.
3. High Yield
Once you have decided on CD length, shop around to find the highest yield being offered at that length.
4. Low early withdrawal penalty
CDs carry a penalty for withdrawals made before the maturity date, but the penalties vary. Assuming the yield is competitive, look for a CD with a relatively low penalty because that will give you some flexibility if there is a significant move in interest rates.
Finally, in a few years when the maturity date of this CD is approaching, you should consider these issues anew with respect to your next CD, rather than letting the existing one roll over automatically at the same length and the same bank.
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