Individual retirement accounts, or IRAs, are long-term savings accounts that carry various tax advantages granted by the Internal Revenue Service. As many investors consider their IRA account to be their "nest egg," IRAs are often invested in conservative products. Certificates of deposit, or CDs, are low-risk, low-return investments issued by banks and frequently purchased in IRAs. CDs are not restricted to being purchased in IRAs, however, and can be bought in any investment account.
Certificates of Deposit
A certificate of deposit is essentially a short-term loan that you offer to a bank or thrift institution. In exchange for your promise to leave your money with the financial institution for a specified period, you receive interest payments at regular intervals. If you sell a CD before the agreed-upon maturity date, however, you usually have to pay a penalty of a few months of interest. CDs offer investors an alternative to the generally low interest rates that money market accounts pay and yet carry a high degree of safety, as each CD is insured by the Federal Deposit Insurance Corp. up to $250,000 per owner.
Individual Retirement Accounts
Traditional IRA accounts are funded with pretax dollars, meaning you can usually take a deduction on your taxes when you make an IRA contribution. Both contributions and earnings in an IRA grow on a tax-deferred basis until distribution, when all IRA funds become taxable at ordinary income rates. To encourage investors to save their money until retirement, the IRS imposes a 10 percent penalty on any withdrawals taken before age 59 1/2.
Rates
CD rates are typically better than money market or savings rates since you're leaving your money with the financial institution for a period of time. In a money market or savings account, you can withdraw your money at any time, meaning the bank cannot generally lend out your funds but must have them available for your immediate need. Since the bank is not earning much or any interest on your funds, you are paid a correspondingly low rate. With a CD investment, the bank does not need to return your funds for a specified period of time and can use that time to earn interest on the money.
Misconceptions
Strictly speaking, there is no such thing as an "IRA CD." You can certainly buy a CD within an IRA, but the label "IRA CD" is more of a marketing gimmick, meant to imply that some CDs are specific to an IRA account. Any CD that you can purchase in your IRA, you can also purchase in your regular taxable investment account, and it will carry the same interest rate and level of security.
Availability
Unlike stocks, CDs have no centralized exchange where you can buy any CD you'd like. Although some CDs offered by other institutions may be available, typically if you open an account at a bank, only that particular bank's CDs will be offered for you to purchase. The available inventory is often greater at brokerage houses, but those CDs may cost you more in commissions.
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