Individual retirement accounts (IRAs) are popular investments that many use to grow their retirement nest eggs. Some people prefer IRA CDs, however, which are special types of IRAs that only invest in CDs. They offer several important benefits that are worth considering if you are nearing retirement or you’re already retired.
How Do IRA CDs Work?
An IRA is a type of retirement account that is set up by an individual. Unlike 401(k) accounts, they are not offered by employers.
There are two primary types of IRAs—traditional and Roth. The main difference is in how they are taxed. With a traditional IRA, the money you contribute is taxed when you make withdrawals. With a Roth IRA, you make contributions with money that has already been taxed and your withdrawals are not taxed.
IRAs invest in a portfolio of assets that often include stocks and bonds. An IRA CD, however, only invests in certificates of deposit (CDs). IRA CDs are typically offered by banks, credit unions, and brokerage firms.
What Are the Advantages of IRA CDs?
IRA CDs have several important advantages to consider. They are great options for those who are looking for safe investments with guaranteed returns.
Your Money Is Safe
When you invest in an IRA CD, you can be assured that your money is safe. It is backed by the federal government for up to $250,000. If it’s with a bank, it’s backed by the Federal Deposit Insurance Corporation (FDIC). If it’s with a credit union, it’s backed by the National Credit Union Administration (NCUA).
Your Return Is Guaranteed
IRAs that invest in CDs offer guaranteed returns. CDs have fixed interest rates, and you can determine how much you’ll earn before you invest your money.
Different Terms Are Available
The CDs you invest in may have different terms that you can choose from. You could choose a three-month CD, for example, if you think rates will rise in the near future. Terms of up to five years may also be available.
What Are the Disadvantages of IRA CDs?
It’s important to also consider the potential negatives of IRA CDs before investing. Depending on your needs, another investment type may be a better choice.
You Might Miss Out on a Better Investment
When you invest in an IRA CD, your money is essentially locked up until the maturity date. If a better investment comes along, or if interest rates rise, you’ll have to wait until the maturity date to reinvest.
Early Withdrawal Penalties
Although it’s possible to withdraw your money from a CD before the maturity date, you’ll be assessed an early withdrawal penalty for doing so. If you’re withdrawing your money to invest in something with a better interest rate, the penalty could negatively affect the benefits of switching to another investment.
Other Investments May Earn More
Investments in certain stocks and exchange-traded funds (ETFs) may offer higher rates of return than IRA CDs. These investments are usually riskier than IRA CDs, however.
With inflation currently at a 40-year high, the growth of your IRA CD may not keep up with the rising cost of living.
When Should You Consider Opening an IRA CD?
IRA CDs are ideal for those who prefer low-risk investments with guaranteed returns. They may be good options for those who are nearing retirement or are already retired, for example. Although other investments may provide a higher return, retirees can use IRA CDs to earn steady incomes without worrying about losing their money.
How to Open an IRA CD
Opening an IRA CD is simple and easy and can usually be completed in just a few minutes at a bank or credit union. Depending on the financial institution, you may also have the option of doing it online. The following steps outline the process.
1. Shop Around
Before you open an IRA CD, it’s best to shop around to see which financial institution offers the best rates. It’s also important to make sure the bank or credit union you’re considering offers IRA CDs and not just IRAs that invest in portfolios of assets.
2. Select the IRA Account Type
Determining whether to go with a traditional or Roth IRA will have important tax implications. Be sure to consider the pros and cons of each option before making a decision.
3. Open Your Account
To open your account, you’ll need to provide certain documents and information, such as:
- Government-issued ID
- Social Security number
- Beneficiary information
- IRA account type
- Banking information (to fund the account)
4. Fund Your Account
After your account is established, you can start making contributions. There are several ways you can do this including transferring funds from your bank account, writing a check, making an electronic payment, or transferring funds (rollover) from another retirement account.
5. Make Sure Your Funds Are Invested
The last step is to make sure that your contributions are invested in a CD. Be sure to review the different CDs your financial institution offers to see which option is best for your needs.
IRA CD Alternatives
IRA CDs are great options for those who prefer steady, predictable, and safe income. They may not be the best choice, however, for those who want to maximize the growth potential of their retirement accounts. A traditional or Roth IRA that invests in a portfolio of assets instead of CDs may be a better option.
A 401(k), which is a retirement account offered by an employer, is another option to consider. An important benefit of these accounts is that you can contribute more each year than with an IRA. Some employers also offer contribution matching, which means they’ll contribute $1 to your account for every $1 that you contribute, up to a certain amount.
Are CDs a Good Investment for Everyone?
If you’re considering investing in a CD or an IRA CD, it’s important to consider both the pros and cons of CDs to make sure they are a good choice for your needs. Although they do have many important advantages, they may not be the best choice for every situation.
Click on the following link to learn more about the advantages and disadvantages of CDs.