Can I Buy Certificates of Deposit in My IRA Account?

Certificates of Deposit (CDs) are permissible investments within an Individual Retirement Account (IRA). This combination allows investors to benefit from the predictable returns of CDs while leveraging the tax advantages offered by retirement accounts. Understanding how these two financial tools interact can help in constructing a diversified and stable retirement portfolio.

Understanding CDs in an IRA

A Certificate of Deposit (CD) is a type of savings account that holds a fixed amount of money for a fixed period, known as a term, and typically offers a fixed interest rate. When the term ends, the CD reaches its maturity date, and the original deposit, plus accrued interest, becomes available to the investor.

When a CD is held within an Individual Retirement Account, the IRA functions as the account “wrapper” that contains the CD investment. This means the CD itself is the underlying asset, and the IRA provides the tax-advantaged framework for that asset’s growth. The interest earned on the CD within the IRA grows tax-deferred or tax-free, depending on the specific IRA type.

Selecting Your IRA and CD Type

Various types of Individual Retirement Accounts can hold Certificates of Deposit, each offering distinct tax treatments. A Traditional IRA allows for tax-deductible contributions, with earnings growing tax-deferred until withdrawals are taxed as ordinary income in retirement. Contributions to a Roth IRA are made with after-tax dollars, meaning qualified withdrawals in retirement, including earnings, are tax-free. For self-employed individuals and small business owners, Simplified Employee Pension (SEP) IRAs and Savings Incentive Match Plan for Employees (SIMPLE) IRAs also permit CD investments, generally featuring higher contribution limits.

Several types of CDs are available for investment. Standard fixed-rate CDs lock in an interest rate for the entire term, providing predictable earnings. Brokered CDs are purchased through brokerage firms and may offer a wider selection of terms, potentially higher yields, and the ability to sell on a secondary market before maturity. Callable CDs offer a higher interest rate but come with the risk that the issuing bank can redeem the CD before its maturity date, typically if interest rates decline. Step-up CDs feature predetermined rate increases at scheduled intervals throughout their term, providing a rising interest rate over time.

How to Purchase CDs for Your IRA

Purchasing a CD for an existing Individual Retirement Account involves navigating your investment platform, whether a brokerage firm or a bank. Investors access the platform online or through a financial advisor to view available CD offerings. The process includes selecting the desired CD based on term and interest rate, then funding the purchase using the cash balance held within the IRA.

For individuals establishing a new IRA to hold CDs, the initial step involves opening the retirement account with a financial institution. Once the IRA is established, funds must be contributed to it, either through direct contributions, rollovers from other retirement plans like a 401(k), or transfers from existing IRAs. After the IRA is funded, the investor can then proceed to select and purchase CDs from the available options through the institution’s investment portal.

Key Considerations for IRA CD Investments

When considering Certificates of Deposit for an IRA, interest rates are a factor, as they directly impact the potential return on investment. Generally, CDs with longer terms tend to offer higher interest rates, reflecting the longer commitment of funds. Compare rates across various institutions to secure the most favorable yield for your chosen term.

The CD’s term, or maturity date, dictates how long your funds are committed. Terms can range from a few months to several years, with common durations being three months, six months, one year, two years, three years, and five years. Upon maturity, banks typically offer a grace period, often around 10 days, during which investors can decide to withdraw funds, reinvest in a new CD, or choose another option without penalty. If no action is taken, the CD may automatically renew for a similar term at the current interest rate.

Liquidity is a consideration, as funds in a CD are generally locked in until maturity. Early withdrawals from a CD can incur penalties, typically a forfeiture of a portion of the interest earned or, in some cases, a portion of the principal. If the CD is held within an IRA, an early withdrawal from the retirement account itself before age 59½ may also trigger an additional 10% tax penalty from the IRS, on top of the bank’s CD penalty, unless an exception applies.

FDIC insurance provides security for CD investments. Deposits in FDIC-insured banks are protected up to $250,000 per depositor, per insured bank, for each ownership category. For IRAs, this insurance applies in aggregate to all Traditional and Roth IRA deposits at a single institution, up to the $250,000 limit. This protection safeguards the principal amount in the event of a bank failure.

The impact of inflation on the real return of a CD should be considered. While CDs offer fixed returns, high inflation can erode the purchasing power of those returns over time. The actual return after accounting for inflation and taxes may be lower than the stated interest rate.