What Is a Traditional IRA Certificate of Deposit?

by Ciaran John
A CD IRA shelters your retirement nest egg from taxes.

A CD IRA shelters your retirement nest egg from taxes.

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A traditional IRA certificate of deposit is a low-risk, tax-deferred investment option. You can buy IRA CDs from banks, credit unions and brokerage firms. Term times, interest rates and withdrawal rules vary, but as with retirement accounts, withdrawals from CD IRAs are subject to federal tax rules.

Traditional IRA

You deposit cash into a traditional IRA on a pre-tax basis. Your investment grows tax-deferred, which means you pay taxes on neither your principal nor your earnings until you make withdrawals. Under federal tax rules, you must begin making required minimum withdrawals from traditional IRAs when you reach the age of 70 1/2. Withdrawal requirements prevent investors from permanently shielding retirement funds from federal and state income tax. Annual contributions to IRAs are capped based on annually set contribution limits and are also affected by your income level and tax filing status. You can use IRA funds to invest in a variety of instruments including stocks, bonds and CDs.

Certificate of Deposit

A certificate of deposit is a interest bearing investment account with a fixed term time that may last for days, weeks, months or years. Earnings on regular CDs are subject to income tax but earnings on a CD IRA are sheltered from taxes until you make withdrawals. If your CD term ends before you plan to make an IRA withdrawal, you can protect the tax status of your money by rolling the cash into another CD with the same or a different bank or brokerage firm.

Withdrawals

The funds you deposit into an IRA CD at a bank or credit union are normally inaccessible until the end of the CD term. Withdrawals prior to the maturity date incur an interest penalty that may deplete your interest and principal. However, you have a seven-day right of rescission on CD IRAs, which means you get a return of principal if you close the account with a week of first establishing it. You forfeit all of your interest when this occurs. Generally, you cannot prematurely redeem CD IRAs that you buy through brokerage firms. You have to hold these marketable securities in IRA holding accounts until maturity. At that time, the issuer redeems the CD and deposits cash into the IRA account.

Considerations

IRA CDs provide you with predictable levels of return and many investors view these accounts as safe products. The Federal Deposit Insurance Corporation insures IRA CDs up to $250,000 per account holder, per bank. The National Credit Union Administration provides the same level of coverage for IRA CDs offered through credit unions. Brokerage CDs are not federally insured unless the CDs are actually issued by banks.
Despite the safeguards, IRA CDs expose you to inflation risk -- the danger that inflation will outpace the steady but low levels of return on your investment. Additionally, aside from bank-imposed surrender penalties, most IRA CD withdrawals made prior to the age of 59 1/2 incur a 10 percent federal tax penalty in addition to any income tax due.

About the Author

Ciaran John began writing in 1994 with contributions to "The Hourly Press" and "The Sawbridgeworth Observer," and has since written for many online and print publications. He has 12 years experience working for financial services companies as a business banker, lender and investment representative and spent four years working in human resources.

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