Everyone should be saving for retirement as soon as they can. It’s a long-term process, and the best option for most people is to diversify their investments to reduce risk and maximize returns. One common way to save for retirement is by contributing to an individual retirement account (IRA).
An IRA provides significant tax-advantages, either by allowing for a tax-free deposit through a traditional IRA or allowing for tax-free growth through a Roth IRA. Within the IRA account, an investor can purchase investments like stocks, bonds, and mutual funds.
Jump to a section:
- What is the Difference Between a CD and an IRA CD?
- Pros of Investing in an IRA CD
- Cons of Investing in an IRA CD
What is a Certificate of Deposit?
A certificate of deposit (CD) is a savings vehicle issued by a bank to someone who’s depositing money with the institution for a pre-determined period of time. CDs earn a fixed rate of interest during the length of the term.
The CDs maturity date can be months or, more commonly, years. If you remove your money from a CD before it matures, you will pay a penalty. Generally, the longer the term of a CD, the more interest you’ll get paid on it.
What is the Difference Between an Ordinary CD and An IRA CD?
An IRA CD refers to an IRA where the money is invested in a CD as opposed to the stock market or bonds.
If you allocate your IRA funding to a CD, you’ll get tax advantages that you would not get if you purchased an ordinary CD which would be purchased with taxed income. With ordinary CDs, the profit you receive from them is also taxed.
If someone opts to invest in a CD as part of their IRA, they can purchase any CD. However, some financial institutions have CDs specifically for retirement savings. These CDs usually have longer term lengths of 10 years or more, and they may have higher minimums and higher yields.
What Are the Pros of Investing in an IRA CD?
Investing in an IRA CD is considered a safe investment strategy. There’s no direct risk associated with CDs, as opposed to investing in stocks or bonds. And investors can rely on the regular interest income and be rest assured that they can avoid losses.
A low-risk CD is a good way to diversify your retirement portfolio, especially if you’re heavily invested in high-risk stocks. The money you invest in a CD is also FDIC-insured.
What Are the Cons of Investing in an IRA CD?
As with most safe, secure investments, you will not see very high returns with an IRA CD. The return rates are usually between 1 and 2 percent. This means that investing in an IRA CD might not even help you keep up with inflation.
Having the safety of an IRA CD as one component of a diversified portfolio might be a great way to hedge against risk, but putting all of your money into an IRA CD is probably not going to be the best option for maximum gains.
In addition, other investment options can offer low-risk solutions for your portfolio and with higher returns. Many bond options, both government and corporate, as well as numerous high-yield savings accounts can also help investors generate modest profits while minimizing risk.
An IRA CD may be one way to save for retirement, but because of the low rate of return, it shouldn’t your only investment vehicle. Create a portfolio with high and low risk levels for the best long-term outcome. Also, if you do decide to invest in an IRA CD, make sure you compare different financial institutions and products. They can vary significantly.