What is the Difference Between an IRA & a CD?

Individual Retirement Accounts (IRA) are an extremely popular way for Americans to save for retirement. Unfortunately, many new investors don't understand their basic function. Banks and other financial companies may try to take advantage of this by advertising investments like CDs as if they were actually IRAs, making customers believe that they must have a certain product in order to have an IRA. Nothing could be further from the truth.

Identification

IRAs are a type of account, not a type of investment. When you open an IRA, you are simply creating a holder for your money. What you decide to do with the money once it is inside the IRA is completely up to you. It can be invested in almost any financial product, including stocks, bonds, mutual funds, CDs or real estate.

Significance

CDs (Certificates of Deposit) are time deposits, meaning that you give the bank a sum of money for a set amount of time, and in return for that, they pay you a guaranteed rate of interest. Because you are promising the bank that it will have control of your money for a certain period, there are usually penalties if you decide to pull your money out of the CD before it matures. CDs usually pay a slightly higher interest rate than savings accounts, but they are much less flexible.

Types

CDs are very basic investments and are marketed in a variety of ways by banks. Education CDs, IRA CDs, Jumbo CDs and other types are common. These labels are largely marketing, however. Unless they are held inside of accounts that have specific rules and limitations (like IRAs, 529 accounts or Coverdell accounts), a CD is just a CD, whether it has an "IRA" label on it or not.

Warning

Although banks market them aggressively, CDs are not always an optimal choice for IRA investments. Their interest rates are typically only slightly higher than inflation, and most investors are looking for much higher returns than that on their retirement money. When opening an IRA, remember that you should decide what type of investments you want in the account, then open the account at a financial institution that sells that type of investment.

Considerations

If you want to invest some of your retirement money in CDs, look for the best interest rates and terms, not the CD that has an IRA label. Virtually any CD can be held inside an IRA account.

Resources

• CDs at sec.gov
• IRAs vs. Mutual Funds