Business & Finance Personal Finance

Definition of an IRA CD

    Function

    • A CD, or Certificate of Deposit, is an interest paying deposit account that generally pays a higher interest rate than a standard savings account in exchange for a required specified length of deposit. An IRA account shields that interest from taxes until the money is withdrawn from the account.

    Benefits

    • By earning more interest than a standard savings account, a CD will allow a person to accumulate more funds for retirement. By preventing the owner from having to pay taxes on the CDs interest, the IRA account also allows a person to accumulate additional funds for retirement as taxes do not need to be diverted from the retirement goal.

    Misconceptions

    • Since most banks are not able to directly offer investments, many banks aggressively market CD based IRA accounts to their customers. This creates the perception that there is a difference at the IRA level between CD-based IRA accounts and IRA accounts with more traditional investments. An IRA is nothing more than a special tax status that can be assigned to many different types of investments including CDs, mutual funds, stocks, bonds, real estate and even regular savings accounts. The rules and regulations for IRA accounts are the same across all types of investments.

    Considerations

    • Investing in a CD for retirement savings provides a higher rate of interest than other bank products. Because a CD generally requires a specific length of time for the money to stay in the CD, match up that length with any need for the funds. In the case of a person far from retirement, this isn't a big concern. In the case of someone nearing retirement or already in retirement, have sufficient funds for use during the time the remaining money is locked up in the CD.

    Warning

    • Although CDs pay a higher interest rate than other savings accounts, they traditionally do not return as much as other investments over a longer period of time. Thus, a person with several years until retirement may be much better served by investing for their retirement in other investment products within their IRA.

    Time Frame

    • A CD has a time frame equal to the length of time the money is required to be left within the CD. A 5-year CD then has a time frame of five years. The IRA, on the other hand, has various rules and regulations regarding the use of the funds within it. These rules provide for tax penalties if money is withdrawn from the account prior to age 59 1/2. However, a new CD can be purchased or rolled-over into within the structure of an IRA account allowing for a new CD to be purchased without tax implications.

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