What Is the Difference Between a CD and an IRA?

Certificates of Deposit (CDs) and Individual Retirement Arrangements (IRAs) are common financial products for savings and investments. While both relate to personal financial planning, they serve different purposes and have distinct characteristics. Understanding these differences is important for informed financial decisions.

Understanding Certificates of Deposit

A Certificate of Deposit (CD) is a savings account offered by banks and credit unions. It allows an individual to deposit a fixed amount of money for a predetermined term. In return for locking up funds, the financial institution pays a fixed interest rate, which is higher than standard savings accounts.

A CD is an investment product, not an account designed to hold various investments. The principal and interest are protected by federal insurance. Deposits at banks are insured by the Federal Deposit Insurance Corporation (FDIC), and those at credit unions by the National Credit Union Administration (NCUA). This insurance covers up to $250,000 per depositor, per institution, per ownership category.

CD terms range from a few months to several years, with longer terms often providing higher interest rates. A penalty applies for early withdrawal before the maturity date. This penalty typically involves forfeiting a portion of earned interest, and in some cases, may impact the principal if accrued interest is insufficient.

Interest earned on a standalone CD is considered ordinary income and is taxable in the year it is earned. Financial institutions report interest earnings of $10 or more to the IRS on Form 1099-INT. Taxes are owed annually on the interest accrued, even for CDs with terms longer than one year.

Understanding Individual Retirement Arrangements

An Individual Retirement Arrangement (IRA) is a tax-advantaged investment account for retirement savings. Unlike a CD, an IRA can hold various investment types, including stocks, bonds, mutual funds, exchange-traded funds, and Certificates of Deposit.

Traditional and Roth IRAs are the two primary types. A Traditional IRA allows for potentially tax-deductible contributions. Investment growth is tax-deferred, with taxes paid on earnings only upon withdrawal in retirement. Withdrawals are typically taxed as ordinary income.

A Roth IRA is funded with after-tax contributions. Qualified withdrawals in retirement, including both contributions and earnings, are entirely tax-free. To qualify, the account must generally be open for at least five years, and the account holder age 59½ or older, or meet other criteria.

The IRS sets annual contribution limits for both IRA types. For 2025, individuals under 50 can contribute up to $7,000, and those 50 and older can add $1,000, totaling $8,000. Withdrawals before age 59½ are generally subject to a 10% federal penalty tax, plus regular income tax, unless an exception applies. Traditional IRAs have Required Minimum Distribution (RMD) rules, mandating withdrawals begin at age 73. Roth IRAs are not subject to RMDs for the original owner.

Key Differences

A CD is a specific financial product, a time deposit with a bank or credit union, designed for short to medium-term savings with a fixed, predictable return. An IRA is an investment account, a tax-advantaged structure for long-term retirement savings, capable of holding various investment products.

Their tax treatments vary significantly. Interest on a standalone CD is taxed annually as ordinary income. Investments within an IRA benefit from tax advantages: Traditional IRA earnings grow tax-deferred, and qualified Roth IRA withdrawals are tax-free. This means CD interest is taxed annually, while an IRA defers or eliminates taxation on growth.

The scope of investment options also differs. A CD is the investment itself, offering a fixed interest rate and guaranteed return. An IRA provides a broad universe of choices, including stocks, bonds, and mutual funds, allowing for diverse strategies and varying risk potentials. An IRA’s performance is tied to market fluctuations, while a CD offers stability.

Liquidity and access to funds also differ. CDs have fixed terms, and early withdrawals incur penalties. IRAs also have penalties for withdrawals before age 59½, though underlying investments might be more liquid. Accessing IRA funds prematurely typically results in a 10% federal penalty tax on taxable amounts.

Risk and return profiles reflect their structural differences. CDs offer a low-risk, fixed-return environment, suitable for capital preservation and predictability. Returns are modest but guaranteed. IRA investments carry variable risk and potential for higher returns, but also risk of loss due to market volatility.

Using CDs Within an IRA

A Certificate of Deposit can be held within an Individual Retirement Arrangement, a strategic choice for some investors. This involves opening an IRA and purchasing a CD as an investment within it. When a CD is held within an IRA, its interest benefits from the IRA’s tax advantages.

In a Traditional IRA, the CD’s interest growth is tax-deferred, with taxes due only upon withdrawal in retirement. If held within a Roth IRA, interest grows tax-free, and qualified withdrawals are tax-free. This contrasts with a standalone CD, where interest is taxed annually.

While placing a CD within an IRA offers tax benefits, its fixed, modest return contributes to a long-term retirement goal. CDs provide a low-risk option for a portfolio, particularly for stability or a fixed-income component. However, a CD’s fixed return may not keep pace with inflation or offer the growth potential of more volatile investments. This approach helps diversify a retirement portfolio and reduce overall risk.