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Pros and Cons of IRA CDs

IRA CDs have significant pros and cons. Whether an IRA CD is the right choice for your retirement portfolio depends on your priorities and, to some extent, how close you are to retirement.

IRAs let you save for retirement without going through your employer. Furthermore, an IRA CD lets you lock in a CD-style interest rate in the form of a term-based retirement account.

• IRA CDs could be a worthwhile option if you're nearing retirement and looking for a safe investment. See our IRA Certificate rates »

How an IRA CD Works

An IRA CD is a type of retirement account that invests your funds in a certificate of deposit (CD). When you open a regular CD, you're putting away money for the near future — with an IRA CD, your CD is part of your long-term retirement savings strategy.

Most financial institutions allow you to choose between a Traditional and Roth IRA CD. An IRA CD follows most of the same rules as any other IRA. You're limited to a certain amount in contributions per year, and you'll pay the usual taxes and penalties for early withdrawals that you would with any other Traditional, Roth, or SEP IRA.

This means you'll contribute after-tax dollars to a Roth IRA CD, and you won't pay taxes when you withdraw money. For a Traditional IRA CD, you'll typically contribute money before taxes are taken out, then pay income tax on withdrawals.

Benefits of IRA CDs

The primary benefit of IRA CDs is stability. Your account value will not fluctuate, and your interest earnings are completely transparent. If you are retired or nearing retirement, this stability can be reassuring—and may save you from having your account value plummet just as you're hoping to use it for reliable income. Consider an IRA CD if you want the following benefits:

Predictable income: A CD is a stable asset. You know upfront how much interest you'll earn and for how long. That predictability can help you plan your retirement savings because you know exactly how much you’ll earn from a CD.

Safety from loss: Your money doesn't lose value in a CD. By contrast, the value of growth assets like stocks and exchange-traded funds (ETFs) can rise and fall with the market. You may see greater returns on growth investments, but you may also experience losses.

Federal insurance: IRA CDs from banks or credit unions are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Association (NCUA). So long as you open an IRA CD with an NCUA or FDIC-insured institution, your savings are insured for up to $250,000.

A straightforward investment tool: There isn’t a lot to consider when choosing one and it isn’t likely to make adjustments throughout its life. Investing in an IRA CD is easier and less time-consuming than designing and managing your own investment portfolio.

No brokerage fees: Investments are usually subject to management fees. Depending on how you invest, you may have to pay brokerage fees and expense ratios. Fees eat into your retirement savings and may only make it harder for you to reach your goals. With a CD, you won’t have those fees.

Additional stability: Keeping a portion of your retirement portfolio in an IRA CD earning fixed interest for a few years can help balance out risk.

Drawbacks of IRA CDs

Limited returns: An IRA CD may not be the best match for anyone wanting to take risks with investments. If you're young, you probably have time to take riskier investments that will earn you more in the long run.

Contribution limits: Although you can invest existing IRA funds in CDs to avoid contribution limits, new contributions are limited by the IRS.

Active scheduling: You can usually set up your IRA CDs to roll over automatically after they mature, but it's a good idea to manage your CDs actively. Use the window between one CD maturing and the next one opening to check interest rates, add funds or move your money to a different investment.

Potential penalties: You could end up paying considerable early withdrawal penalties. You'll pay the financial institutions’ early withdrawal penalties if you take out funds before the CD matures. You'll pay the usual 10% fee if you withdraw from an IRA before age 59 1/2. And if you withdraw before the IRA CD matures and before you turn 59 1/2, you'll pay both penalties.

Generally, your retirement savings strategy should change as you approach retirement. If you have a significant number of years left to invest, you'll likely want to take on more investing risk than an IRA CD can provide. If you're retiring in the next few years, however, an IRA CD can be a less risky option for investing with a guaranteed rate of return.

This content is for informational purposes only and is not to be considered advice or a recommendation of any specific investment product or strategy. Before acting on any information in the content of this article, you should seek the personalized advice of legal, tax, or investment professionals. 

Sources: An IRA CD is a conservative investment account for people nearing retirement. | What an IRA CD Is, Rates and How It Works