An Individual Retirement Account (IRA) is a long-term savings and investment account that provides various tax advantages. Almost any type of investment is permitted in an IRA, including certificates of deposit. A certificate of deposit is a savings investment usually issued by a bank and insured by the federal government. While there is no specific investment known as an "IRA CD," CDs are popular IRA investments.
IRA Characteristics
One of the main investment benefits of an IRA is that contributions and earnings grow on a tax-deferred basis, so you don't have to pay income tax on the gains you make every year. Many investors place investments with high tax liabilities within their IRA accounts, and keep the low-tax investments in a regular investment account. High-tax investments that might be suitable for an IRA account include bonds or other income investments that pay a lot of interest or dividends, or stocks that are frequently traded on a short-term basis.
CD Returns
A certificate of deposit provides an investment return in the form of interest rather than capital gains. Some CDs pay a monthly dividend, while others return all of their interest in one payment when the CD matures. CDs are safe, taxable investments, so they are suitable for the IRA accounts of many investors. Retirement savings are often invested more conservatively than regular savings, and the tax-advantaged features of an IRA account help to enhance the net return that a CD provides.
Fees
Some financial services firms will charge you an annual fee to maintain your IRA for you, but other firms have no-fee IRAs. Similarly, some firms charge commissions or other fees if you buy a CD, while others allow you to purchase CDs at no charge. As the financial services industry is highly competitive, shop around before you decide on where to open an IRA account and purchase a CD.
Taxation
No matter what investments you purchase in your IRA, all distributions from the account are taxable at ordinary income tax rates. While you can enjoy the benefits of tax-deferral all the way until you turn 70 1/2, at that point the IRS requires that you being taking distributions from your account.
Penalties
While you can sell some CDs on the secondary market like any other bond, other CDs must be held until maturity, or you will sacrifice a few months' interest--usually 3 months. If you take any distributions from your IRA before you reach age 59 1/2, the IRS will charge you a 10 percent early withdrawal penalty. Once you reach age 70 1/2, you will incur a 50 percent penalty if you do not initiate your required minimum distributions.
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