Which Is Better for Saving: an IRA or a CD?

Making informed decisions about saving and investing is crucial for future financial goals. Individual Retirement Arrangements (IRAs) and Certificates of Deposit (CDs) are common options for setting aside funds. This article examines these two distinct financial products, their structures, and potential applications for savers.

Understanding Individual Retirement Arrangements

An Individual Retirement Arrangement (IRA) is a savings vehicle designed to help individuals accumulate funds for retirement. An IRA is an account that holds various types of investments, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), and Certificates of Deposit. The primary benefit of an IRA stems from its tax advantages, which encourage long-term savings.

Two primary types of IRAs are Traditional IRAs and Roth IRAs. Contributions to a Traditional IRA may be tax-deductible, depending on income and participation in an employer-sponsored retirement plan. Funds within a Traditional IRA grow on a tax-deferred basis, meaning taxes are not paid on investment gains or income until withdrawals are made in retirement. Distributions from a Traditional IRA are taxed as ordinary income in retirement.

A Roth IRA is funded with after-tax dollars. The advantage of a Roth IRA is that qualified withdrawals in retirement are entirely tax-free. This includes both contributions and earnings, provided certain conditions are met, such as having the account open for at least five years and the account holder being age 59½ or older.

For 2025, the annual contribution limit for both Traditional and Roth IRAs is $7,000 for individuals under age 50. Those age 50 and older can make an additional “catch-up” contribution of $1,000, bringing their total annual limit to $8,000. Eligibility to contribute to a Roth IRA is subject to income limitations, with phase-out ranges for Modified Adjusted Gross Income (MAGI) varying based on filing status. For instance, in 2025, single filers must have a MAGI under $150,000 to contribute the full amount, while married couples filing jointly must have a MAGI under $236,000.

Withdrawals from an IRA before age 59½ are considered early and may be subject to a 10% federal income tax penalty, in addition to regular income tax on the amount withdrawn from a Traditional IRA. Exceptions to this penalty include withdrawals for qualified higher education expenses, a first-time home purchase (up to $10,000 lifetime limit), certain unreimbursed medical expenses, or if the account holder becomes disabled. For Roth IRAs, contributions can be withdrawn at any time, tax-free and penalty-free. However, earnings withdrawn from a Roth IRA before age 59½ or before the five-year holding period is met may be subject to taxes and the 10% penalty, unless an exception applies.

Understanding Certificates of Deposit

A Certificate of Deposit (CD) is a type of savings account offered by banks and credit unions, characterized by a fixed interest rate and a specified maturity date. When an individual purchases a CD, they deposit a fixed sum of money for a predetermined period, ranging from a few months to several years. In exchange for committing funds for this term, the financial institution typically pays a higher interest rate compared to a standard savings account.

The deposited principal earns interest at the agreed-upon rate until the maturity date. Upon maturity, the original principal, along with all accrued interest, becomes available to the depositor. Common maturity terms include 3 months, 6 months, 1 year, 2 years, or 5 years.

CDs impose a penalty for early withdrawal. If funds are needed before the CD reaches its maturity date, the issuing institution imposes a penalty, which often involves forfeiting a portion of the interest earned or, in some cases, a portion of the principal if sufficient interest has not yet accrued. This encourages depositors to hold their funds for the full term.

CDs are low-risk investments because the principal amount deposited is protected. This protection comes from deposit insurance provided by government agencies. In the United States, deposits in CDs held at federally insured banks are covered by the Federal Deposit Insurance Corporation (FDIC), up to $250,000 per depositor, per insured bank, for each account ownership category. Credit union deposits are insured by the National Credit Union Administration (NCUA). This insurance safeguards against the loss of funds in the event of the financial institution’s failure, making CDs a secure option for preserving capital.

Key Differences and Considerations

When evaluating whether an IRA or a CD is suitable for savings, understanding their fundamental differences and how they align with personal financial objectives is necessary. An IRA is an account type that can hold various investments, including CDs, while a standalone CD is a specific investment product.

The primary investment objective for an IRA is long-term retirement savings. A standalone CD typically serves as a vehicle for short-to-medium term savings goals, such as saving for a down payment on a home, a significant purchase, or preserving capital with minimal risk over a defined period.

Tax treatment represents a significant distinction. Interest earned on a standalone CD is generally taxable in the year it is earned, unless the CD is held within a tax-advantaged account like an IRA.

Growth potential differs considerably due to the nature of the underlying investments. An IRA, as an investment account, can hold a diverse portfolio of assets, including stocks and mutual funds, which offer the potential for substantial capital appreciation over time, albeit with higher risk. While an IRA can hold a CD, the growth of a standalone CD is limited to its fixed, predetermined interest rate, which is typically lower than the potential returns from more volatile investments. This fixed rate provides predictability but less opportunity for significant growth.

Access to funds and liquidity also vary. A standalone CD imposes penalties for early withdrawal, typically a forfeiture of interest, but the principal is generally accessible if needed before maturity, though at a cost. The liquidity of a CD is tied to its maturity term, making funds less immediately available without penalty than a standard savings account.

The safety of an IRA’s principal depends entirely on the investments held within the account. If an IRA holds volatile investments like stocks, the principal can fluctuate and is not insured against market losses. If a CD is held within an IRA, that specific portion of the IRA benefits from the CD’s principal protection and FDIC insurance, combining the tax advantages of the IRA with the security of the CD. The choice between a standalone CD and an IRA, or even incorporating CDs into an IRA, depends on an individual’s specific financial goals, time horizon, risk tolerance, and tax situation.