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IRAs can be a valuable tool for saving for retirement, and holding certificates of deposit (CDs) in an IRA can offer potential tax deductions.
Whether you qualify for a deduction depends on multiple factors, including your filing status, modified adjusted gross income and access to an employer-sponsored plan, like a 401(k). As long as it’s below the annual contribution limit, any money you place in a traditional IRA can potentially be tax deductible.
You get to pick the investments that will be held in your IRA. If you’re eligible for the IRA deduction, that’s the case regardless of whether you keep your IRA contributions in certificates of deposit (CDs) or other investment vehicles.
Are IRA CD contributions tax deductible?
Contributions to a traditional IRA CD could potentially be deducted from your taxes. However, this is dependent on your income and whether you or your spouse, if applicable, are covered by an employer’s retirement plan. The ability to make deductions gradually reduces as your income hits certain thresholds, which are updated annually.
For an individual who has access to a company retirement plan, the income limit is between $77,000 and $87,000 in 2024. For couples who file their taxes jointly, if the spouse contributing to the IRA has access to a company retirement plan, the income limit for deductions is between $123,000 and $143,000.
However, if you are contributing to an IRA and don’t have a company retirement plan but are married to someone who does, the limit for deductions is between $230,000 and $240,000. For those who are married and file taxes separately and have access to a company retirement plan, the deduction range remains between $0 and $10,000.
Note that while you can’t deduct contributions to Roth IRAs, qualified withdrawals are tax-free, offering a potential tax benefit when you retire.
Holding CDs in an IRA
Holding CDs in an IRA could be worth considering, particularly if you’re risk averse or you’re nearing retirement and need a short-term account to tap into. Otherwise, it’s probably best to invest your IRA contributions elsewhere.
“You’re obviously talking about a cash account that has limited growth potential and you have to look and see whether that makes sense,” says Matt Etzler, founder of Etzler Financial Advisors in Red Bluff, California.
How could having CDs held in an IRA be a bad move for some investors? In a low-interest-rate environment, you’ll end up with a low average yield, says Chantel Bonneau Stewart, a wealth management advisor at Northwestern Mutual in San Diego.
Putting some of your retirement savings into investments that are less risky may seem wise, especially if you’re fearful of an economic slowdown. But whether you decide to keep CDs, stocks or mutual funds in an IRA should depend on your long-term financial goals and tolerance for risk.
“You always have to look at your risk tolerance,” Stewart says. “That’s what should dictate if you choose to be in the market or you choose to have a CD or you choose to split those dollars.”
Choosing the best IRA CD
Shopping for a CD that you’re planning to hold in an IRA is just like looking for a standard CD. You’ll need to consider both the CD’s yield and the term. When rates are rising, shorter terms can ensure money is freed up to be reinvested if rates climb higher, When rates are already high and may drop, a longer term can guarantee your money will earn a high rate regardless of greater economic conditions.
Look for a bank that insures deposits up to the limit for each account holder for each qualified account type ($250,000).
Finally, decide whether you’re looking for a bank that only appeals to you because of its high-yield CDs or an institution that meets several of your financial needs, like offering low rates on mortgages and advanced digital features.
Taking taxes into consideration
In addition to potentially getting the IRA deduction, having a traditional IRA means you won’t pay taxes on contributions or any interest you earn until you withdraw it in retirement. In contrast, if you opened a Roth IRA, you wouldn’t qualify for a deduction, but your distributions in retirement would be tax-free.
Whether you choose CDs or mutual funds held in an IRA, it’s prudent to act cautiously when moving funds in and out of a retirement account. If you withdraw money from a traditional IRA CD before the end of the term and you’re under age 59½, it’s necessary to pay income taxes and a 10 percent penalty (unless you’re exempt under an IRS rule). On top of that, you could be penalized by your bank or credit union for making an early withdrawal from the CD.
When your IRA CD matures, request that your bank directly transfer those funds into another investment held in your IRA. Avoid a rollover, which gets reported to the IRS and must be deposited to the receiving account typically within 60 days, says Denise Appleby, CEO of Appleby Retirement Consulting in Grayson, Georgia.
Pros and cons of an IRA CD
While it’s clear that an IRA CD can present certain tax advantages, like any investment, it comes with its own set of pros and cons.
Pros of an IRA CD:
- Stable and reliable returns: This makes them especially useful for individuals in or nearing retirement.
- Higher interest rates: Typically, these are higher than standard savings accounts, allowing greater potential earnings.
- Tax advantages: You won’t have to pay taxes on any interest gained within the tax year. Plus, there’s an option to either defer your taxes till retirement or completely evade them with a Roth IRA.
- Lower fees: Most IRA CDs don’t come with heavy fees, unlike other investment avenues that might impose a monthly management charge.
- Security: IRA CDs from institutions that are members of the FDIC or NCUA are insured up to an amount of $250,000.
Cons of an IRA CD:
- Lack of easy access to your cash: The fixed-term nature of the investment could prove troublesome if you need to liquidate your assets quickly in a crisis, as you might incur penalties for early withdrawal.
- Lower returns in comparison to a diversified portfolio of stocks and bonds: This makes them less appealing for young investors or those aiming to amplify their retirement funds.
- Managing several IRA CD accounts can be challenging: Especially if you’re chasing the highest rates across various banks or credit unions.
- May be overly cautious for long-term growth: Particularly if you’re still some years away from retirement.
FAQs
IRA CDs are special certificates of deposit held within an IRA, offering tax-deferral benefits on the interest earned. They may have higher interest rates than regular CDs, as banks consider the funds to be more stable. Additionally, IRA CDs can come with lower fees but often include penalties for early withdrawal. Regular CDs are taxed annually and are better for short-term savings, without the tax advantages of an IRA.
Upon the maturity of an IRA CD, you can renew the CD, transfer the funds to a different CD or financial institution’s IRA, or make withdrawals if you are at retirement age. Withdrawing from a traditional IRA CD at maturity will incur taxes. Without specific instructions from you, the bank may automatically renew or roll over your CD.
Bottom Line
While holding CDs in an IRA can provide tax benefits, it’s crucial to carefully evaluate your long-term financial goals and risk tolerance before making any investment decisions. It’s also important to be cautious when withdrawing funds from an IRA CD before maturity, as it can result in penalties and taxes.
Choosing the best IRA CD should involve considering the CD’s yield, term and the financial institution’s offerings.
– Bankrate’s René Bennett contributed to updating this article.
