CD Vs IRA - Evaluating Savings Options

Let’s take a look at the differences between a Certificate of Deposit (CD) and an Individual Retirement Account (IRA).

Individual Retirement Account (IRA) Vs. Certificate Of Deposit (CD)

An IRA and a CD are two savings account types that can be obtained at financial institutions, such as banks. While both accounts are designed to help individuals save money, they are inherently different overall. A CD is considered a short-term savings account, while an IRA is best for long-term retirement investing.

IRAs have tax advantages to the saver and restrictions on how it can be used before retirement age is reached. The account holder can contribute to this account every year, up to the limits set by the IRS. Essentially, a CD is equivalent to a savings account. The account holder will get a little more interest in return for keeping the money in this account for a set amount of time, typically from six months to five years.

Anyone with an IRA account can choose to invest the money in any of a large variety of stocks, mutual funds, bonds, and exchange-traded funds (ETFs). Account holders can even choose to invest some of it in CDs.

CD Details

A CD is a savings instrument issued and administered by banks, brokers, and credit unions. It is widely considered one of the safest investments you can make. A CD will pay a little more interest in return for committing to keep your money in the bank for a specific amount of time.

These accounts are much safer than stocks, but they will not offer high returns. CDs are insured by the FDIC if they are ultimately issued by an FDIC-insured bank.

Typically, CD’s do not allow individuals to add to their balance. Once you make the initial deposit, the balance will be locked in to keep earning interest until the maturity date. This is part of the reason that CDs do usually offer higher interest rates than other deposit account types.

When you invest in a CD, you commit to locking your money away for a specified period of time. You cannot add to the balance and there will often be steep penalties to pay when choosing to withdraw your money early. You will get a greater return on your deposit in exchange for less liquidity.

IRA Details

The IRA was developed by the federal government to encourage Americans to save money towards their retirement. The account holder can make annual contributions for decades as the balance increases. The IRS does set eligibility requirements, limits on how and when you are allowed to make contributions.

You should consider opening a traditional or Roth IRA alongside your 401(k). A Roth IRA is funded with your after-tax dollars, while the traditional version is funded via pre-tax income. Both of these IRAs allow you to withdraw money without penalty after the age of 59.

If you have any extra money left in your budget at the end of the month, funding IRAs can put you on a fast track to a comfortable retirement. The more time your funds have to grow, the larger they will be come time for retirement.

CD Vs IRA Differences

Let’s take a look at the main differences between these two savings accounts to determine which type is best for your situation.

Account Types

Investors will have many different CD and IRA options to choose from. There are typically four different IRAs that one can invest in, including the following:

Traditional IRA: This allows investors to make tax-deductible contributions.
Roth IRA: These accounts give investors tax-free income.
SEP IRA: Employers can make contributions to a traditional IRA for employees.
SIMPLE IRA: Small business employers and employees will have the opportunity to make matching contributions as long as they have no other active retirement savings plan.

Here are a few things you can do with a CD:

Add-On CD: Add-on CDs will differ from traditional CDs since they allow the depositor to contribute more funds to the account during its term.
CD Laddering Strategy: With a CD laddering strategy, you will purchase multiple CDs, each featuring a different term.

Financial Liquidity

Every financial vehicle will have its own set of objectives and goals. Each type of financial instrument is designed for a specific purpose and therefore comes with its own constraints. Usually, CDs cannot be withdrawn once the account is created. Account holders must wait until the CD term is finished before they get access to their money.

IRAs have an entirely different set up. IRA contributors are allowed to withdraw Roth IRA contributions at any time. However, any earnings cannot be withdrawn until the saver is over 59 years old.

Tax Implications

A big difference between the accounts is how they are treated for tax purposes. IRAs provide a few certain tax breaks to investors. Contributions made to a traditional IRA are tax-deductible, as long as you meet the income and tax-filing status requirements.

CDs, however, do not come with any tax breaks. Your financial institution will send you a Form 1099-INT for any interest earned on your investment. The IRS requires that you report any interest income that comes in over $10.

Conclusion

It’s no secret that an IRA is a better financial vehicle for retirement savings. It will allow savers to have their earnings grow tax-free when utilizing a Roth IRA. If you are not saving for retirement, then a CD is a terrific and safe option.

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