What Is an IRA CD and How Do They Work?

Photo to accompany story about IRA CDs. Getty Images
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2020 is not the time to invest in certificates of deposit.

In previous years CDs, as they’re called, have been a great way to keep your money safe while locking in a guaranteed return. But this year’s economy has sent interest rates on CD accounts plummeting, making them a much less attractive option for savers.

That logic applies to retirement investors, too. 

Retirement accounts such as IRAs offer the chance to put some of your retirement savings in a CD. Putting some of your money in a low-risk account like an IRA CD can be a way to diversify your portfolio. Safety is an important factor to consider in times of economic uncertainty, like during the coronavirus pandemic and the ensuing recession. 

But it comes at a relative cost, and in the case of IRA CDs, that means a very low return on your investment.  

CD rates are currently hovering between 0.65% and 1%, depending on the financial institution.

“Someone who still has quite a bit of time until they retire probably wants to stay away from IRA CDs,” says Brandon Renfro, a financial advisor and assistant professor of finance at East Texas Baptist University, “because that rate of return is going to be significantly lower over the long-term than what they can get from other investments.”

Let’s look at the pros and cons of putting your retirement savings in an IRA CD. 

What Is an IRA CD? 

First, it’s important to know what an IRA and a CD are, to understand how they can function together.

A CD is a type of savings account with a fixed interest; your money is locked in the account for a certain period of time. An IRA is a type of retirement account that allows you to save and invest your money, and comes with big tax breaks.

Pro Tip

If you’re set on putting your retirement in an IRA CD, consider laddering your investments. By opening multiple CDs with different maturity dates, you can better manage your cash flow and hedge your investments against fluctuating interest rates in the future.

Combine the two, and you have an IRA CD. 

“It’s basically a CD that you can get at any bank, but it’s in a tax-deferred IRA,” says Nikki Dunn, a certified financial planner and founder of She Talks Finance. “So essentially what happens is you can take your retirement funds and invest in a CD in your IRA.”

An IRA is more like a home for your investments, whereas the CD can be one of many investments within an IRA. 

“If you’re a conservative investor and the idea of being in the stock market freaks you out, then you may take some of this money or all of it and invest in these lower-risk investments, like IRA CDs. It’s something you can leverage if you have a really low risk tolerance,” Dunn says.

Pros of an IRA CD

A Safe Place to Put Your Money

An IRA CD is an extremely safe place to park your money. CDs are insured by the Federal Deposit Insurance Corporation, so up to $250,000 of your money is protected by the government, even if your bank fails. That’s not the case for other investments like stocks or bonds.

Secondly, your CD interest rate won’t fluctuate once you’re locked in. When you open a CD account, the rate you agree to is the rate you’ll get. You’ll know exactly how much you’ll earn from a CD investment from the start, unless you withdraw early, and that makes it easier for you to plan future retirement goals.

“For someone who has a short-term time horizon, an IRA CD is a very stable way to make sure they don’t lose that value,” says Renfro.

This type of investment, Renfro says, is more desirable if you are nearing retirement age and plan to withdraw in the near term.

Another big advantage of an IRA CD is that you do not pay tax on your retirement savings as they grow. Depending on the type of IRA, you pay tax only before you contribute to the account, or after you withdraw from it.

Easy To Start Investing

Investing in an IRA CD is straightforward. There isn’t a lot to consider when choosing one, and it’s unlikely that you’ll have to make big adjustments to it throughout its term. It’s a lot less time-consuming than designing and managing your own investment portfolio. 

And it’s cheaper than paying someone to manage your retirement funds for you. Management and brokerage fees can eat into your retirement savings and may make it harder for you to reach your goals. 

With an IRA CD, you won’t have to pay any fees as long as you keep your money in the account until it reaches maturity. 

Cons of an IRA CD

Low Return

Low risk equals low return. If your retirement funds are mostly locked away in an IRA CD, you may not earn as much as you would from a mix of stocks, bonds, and other investment options. CD rates tend to fluctuate between 1-2% during normal times, but have dipped even lower during the coronavirus recession

“Especially in a low-interest rate environment like we’re in right now, they’re not going to pay you much interest,” Dunn says. “So you may not hit your retirement goals using this method.”

For an investor many years away from retirement, a better bet would be to invest in target-date funds, which come with more exposure but over the long term are likely to deliver the higher returns you need to outpace inflation and build a nest egg. (For more ideas on setting up a “good-enough” investment portfolio for beginners, see NextAdvisor contributor Erin Lowry’s guide here.)

You’re Locked In

Once you open an IRA CD, your money is locked in that account for a predetermined amount of time. The length of time you agree to could be as short as three months or as long as 10 years; it’s up to you.

But if you try to withdraw money from a CD before it reaches the end of its term, you’ll have to pay an early withdrawal penalty. 

That makes any long-term commitment to an IRA CD somewhat inconvenient, especially if interest rates rise — or if you decide that you’re ready to take on more risky investments.

“If you want to take some risk to increase that expected return, then an IRA CD is not a good choice for you,” Renfro says.