How should you use a certificate of deposit (CD) within an IRA?
There are a few different ways a CD can be useful within an IRA, so you should start by figuring out how you intend to use the CD and then find the best IRA CD rates for your needs.
What are IRA CDs?
IRAs and CDs are really two different things that can be used together.
Individual retirement arrangement
"IRA" stands for "Individual Retirement Arrangement." It is a qualified retirement plan which must be administered by an IRA trustee. Banks and other financial institutions commonly serve as IRA trustees.
As a qualified retirement plan, an IRA is really just a tax structure within which you can use a variety of investments, including CDs. Note that you can have multiple investments within an IRA, including multiple CDs or CDs that roll into new CDs when they mature.
When you open an account with one of these financial institutions, you should be very clear that you intend to set up an IRA and make sure this is reflected on the account paperwork, including the name of the account. That will help to establish the tax status of the account.
The tax status is important because IRAs have certain tax benefits.
In a traditional IRA, your contributions to the account are deductible, and taxes are deferred on any investment earnings in the account. You don't pay taxes until you withdraw money from the account in retirement.
In a Roth IRA, your contributions are not tax-deductible, but investment earnings are not taxed. The big tax benefit really kicks in when you retire, because your withdrawals from the account are not taxable.
How do IRA CD Rates Work?
If you use a CD within an IRA, that CD will earn interest. For the vast majority of CDs, your money is committed for a specified term and the account pays a specific interest rate over the course of that term.
That interest rate should be compared on the basis of annual percentage yield (APY). Banks can have differing policies on how often interest is compounded, which basically means how soon the interest you earn starts earning interest itself. APY measures what the interest rate and the compounding approach of a given product would earn you on an annual basis.
There are two key things to know about CD rates:
- The longer the CD term, the higher the rate will typically be.
So, for example, a 5-year CD will typically earn you a higher APY than a 1-year CD.
- Banks can have very different rates for similar products.
For example, when you compare 5-year CD rates, it's not unusual to see a full percentage point difference in APY between the highest and the lowest rates.
When Should I Get an IRA CD?
As noted earlier, you can have a variety of different investments in an IRA, including CDs. These CDs can be used in your IRA by themselves, along with other CDs, or along with totally different types of investments like stocks or bonds.
To decide whether a CD is a good fit for your IRA, you should think about what you want that portion of your money to accomplish. Here are three examples of roles a CD can play within an IRA:
1. As a stable component of your portfolio
Retirement plans often have lots of long-term investments like stocks. These are expected to earn higher returns over time, but they also represent more risk.
You can water that risk down somewhat by using a CD along with volatile investments like stocks to provide a stable portion of your portfolio. So, while your stocks are going up and down, your CD can be steadily earning interest such that the overall value of your IRA does not fluctuate so wildly.
2. When you are a few years away from retirement
Stability becomes more important as you approach retirement. So, as you get to within five years of retirement age, you might shift more of your money into a five-year CD to provide liquidity once you retire.
3. To manage cash flow in retirement
Even once you retire, you need to manage your investments so that they continue to earn money for you as long as possible but then provide liquidity when you need it.
A CD ladder is a good way to make this happen. A CD ladder is a series of CDs with different maturity dates, so they provide liquidity at different times. For example, you could have a series of CDs with one maturing every year to provide for each year's cash needs in retirement.
What Happens if I Withdraw Early?
A feature of most CDs is an early withdrawal penalty. This is a fee you would have to pay if you took money out of the CD before its maturity date.
For IRA CDs, keep in mind that an even greater factor than the early withdrawal penalty is the tax penalty you would incur if you took money out of the IRA before you reach age 59 1/2.
This tax penalty is 10 percent of the amount you withdraw plus any ordinary taxes owed on that money.
You should always look at the early withdrawal fee before investing in a CD. Still, if the CD is set to mature before you reach retirement age, that fee should not be a big factor in your choice because the tax penalty is so much worse anyway.
Finding the Best IRA CD Rates
There are many banks offering CDs that can serve as an IRA trustee. To pick the right one, decide what role you want the CD to play within your IRA and compare rates to find the best APY for the type of CD you need.
The MoneyRates.com CD page lists hundreds of products you can consider for your IRA. To highlight some of the best choices, the following are profiles of 1-year and 5-year CDs offering the best rates.
As is the case in the examples below, online CDs generally offer the best CD rates. However, MoneyRates also included some branch-based CDs for those who prefer a more traditional approach to banking.
All APYs shown are based on an average of rates offered during the third quarter of 2019.
Best 1-year IRA CD
Bank name: Ally Bank
Avg. APY Q3: 2.47%
Minimum balance: None
Early withdrawal penalty: 60 days' worth of interest on the amount withdrawn
Bank profile: Ally is an online bank based in Sandy, Utah. It was founded in 2004 and had over $117 billion in deposits as of June 30, 2019.
Best branch-based 1-year IRA CD
Bank name: Ridgewood Bank
Avg. APY Q3: 2.10%
Minimum balance: $500
Early withdrawal penalty: 90 days' worth of interest on the amount withdrawn
Bank profile: Ridgewood Bank is headquartered in Ridgewood, New York and has 38 locations, all within the state of New York. It was founded in 1921 and had over $4.4 billion in deposits as of June 30, 2019.
Best 5-year IRA CD
Bank name: Synchrony Bank
Avg. APY Q3: 2.69%
Minimum balance: $2,000
Early withdrawal penalty: 365 days' worth of interest on the amount of principal withdrawn
Bank profile: Synchrony Bank is an online bank based in Draper, Utah. It was founded in 1988 and had over $68 billion in deposits as of June 30, 2019.
Best branch-based 5-year IRA CD
Bank name: Intrust Bank
Avg. APY Q3: 2.57%
Minimum balance: $500
Early withdrawal penalty: 180 days' worth of interest on the amount withdrawn.
Bank profile: Intrust Bank is headquartered in Wichita, Kansas and has 44 locations spread among Kansas, Arkansas and Oklahoma. It was founded in 1876 and had over $4.2 billion in deposits as of June 30, 2019. Intrust Bank offers Time Deposits, which are technically different from CDs but have the same characteristics of a fixed interest rate over a specified period of time and a penalty for early withdrawal.