IRA CD Withdrawal Rules After 59 1/2

An Individual Retirement Arrangement (IRA) that holds a Certificate of Deposit, known as an IRA CD, is a standard IRA that uses a CD as its investment vehicle to secure a fixed rate of return. This structure means that accessing the funds involves navigating two separate sets of regulations. The Internal Revenue Service (IRS) dictates the rules for taking money from the IRA, while the bank that issued the CD has its own rules for when the investment can be cashed.

Understanding the Two Layers of Rules

Once an IRA owner reaches age 59 ½, IRS rules for withdrawals become more lenient. The 10% additional tax on early distributions, detailed in Internal Revenue Code Section 72, no longer applies. This means that from the perspective of federal tax law, you are free to take money from your IRA without this specific penalty.

This federal rule change does not override the terms of the investment held within the IRA. A CD is a time deposit, meaning you agree to leave the money with the bank for a specified term. If you withdraw the funds from the CD before its maturity date, the bank will charge an early withdrawal penalty, regardless of your age. This penalty is a contractual matter separate from any IRS tax or penalty.

The structure of bank penalties can vary but they are commonly calculated based on a set period of interest. For a CD with a term of one year or less, a penalty might be three months of interest. For longer-term CDs, such as those with a five-year term, the penalty could be six or twelve months’ worth of interest. If the penalty is greater than the interest earned, the bank may take the difference from your principal.

Tax Treatment of Withdrawals

Beyond penalties, the primary financial consequence of a distribution is income tax. For a Traditional IRA CD, any withdrawal made after age 59 ½ is a distribution of pre-tax contributions and tax-deferred earnings. Consequently, the entire amount you withdraw is added to your gross income for that year and taxed at your ordinary income tax rates.

The rules for a Roth IRA CD are different, offering the potential for tax-free withdrawals. For a withdrawal to be a “qualified distribution,” and therefore tax-free, two conditions must be met: the owner must be at least 59 ½, and the Roth IRA must have been open for at least five years. This five-year holding period begins on January 1st of the tax year for which the first contribution was made. If you are over 59 ½ but have not met the five-year rule, the earnings portion of the withdrawal is subject to income tax, though the 10% early withdrawal penalty would not apply.

Required Minimum Distributions and IRA CDs

Owners of Traditional IRAs must begin taking annual withdrawals, known as Required Minimum Distributions (RMDs), once they reach a certain age. Under the SECURE 2.0 Act, this age was raised to 73 for individuals who turn 72 after December 31, 2022. This rule does not apply to Roth IRAs during the original owner’s lifetime. The RMD is calculated annually based on the prior year-end account balance.

A complication arises when an RMD is due from an IRA that holds a CD that has not yet matured. The IRS requirement to take the RMD supersedes the bank’s CD terms. An account holder must take the required distribution by the December 31st deadline, even if it forces them to break the CD term and trigger the bank’s early withdrawal penalty.

Failing to take the correct RMD amount by the deadline results in an IRS penalty. The excise tax is 25% of the RMD amount that was not withdrawn. This penalty can be reduced to 10% if the shortfall is corrected in a timely manner. It is almost always more financially sound to take the RMD and pay the bank’s penalty than to miss the RMD and incur the IRS penalty.

The Withdrawal Process and CD Maturity

To initiate any withdrawal from an IRA CD, you must contact the financial institution that holds the account. The process involves completing a distribution request form, specifying the amount you wish to withdraw. The institution will then process the request and issue the funds.

When a CD within an IRA reaches its maturity date, the account holder has a grace period to decide what to do with the proceeds without penalty. One option is to withdraw the cash from the IRA, which would be a taxable event for a Traditional IRA. Another choice is to keep the funds within the IRA and roll them over into a new CD.

A third option is to move the matured funds into a different type of investment within the same IRA, such as a money market fund. This is a reallocation of assets inside the account and has no immediate tax consequences. If no action is taken during the grace period, many banks will automatically renew the CD for the same term at the current interest rate.