Are IRA CDs & Their Rates Different From Regular CD Accounts?
A certificate of deposit, commonly referred to as a CD, is one of the safest and most popular investment instruments available to individual investors. CDs typically have the least amount of risk for the interest rate they produce and are insured by the FDIC up to the maximum allowed by law. Because of their higher yield and safety, many investors put CDs in their Individual Retirement Accounts (IRA), where they typically early rates comparable to non-IRA CDs.
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History
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The Employee Retirement Income Security Act of 1974 first authorized tax deferred contributions by individuals into an IRA. Individuals who were younger than retirement age were allowed to invest up to $1,500 in their IRA and deduct that amount from their income tax. When money is withdrawn in retirement, the initial investment and all income the account generated are taxed as regular income. Congress has since increased the maximum allowable contribution and introduced an additional plan called the Roth IRA that has different tax ramifications.
Function
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IRAs were designed to encourage individuals to save for retirement by allowing them the option of setting aside a portion of their earnings in a tax-advantaged account. The funds may be invested in a wide variety of instruments including stocks, bonds, mutual funds, real estate trusts, precious metals and CDs.
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Features
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Funds used to purchase investments in a traditional IRA are considered to be pre-tax dollars, meaning the account holder can deduct the amount of his IRA contribution from his adjusted gross Income and not pay income taxes on that amount. All income produced by investments held in the IRA are allowed to accrue without tax ramifications until they are withdrawn at retirement age.
Considerations
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Investments held in the IRA may be bought and sold but, with limited exceptions, the funds cannot be withdrawn until the account holder reaches retirement age. If the account holder wishes to withdraw funds from her IRA before retirement age, the Internal Revenue Service will tax the amount withdrawn as ordinary income and assess a penalty. If the account holder has invested in a CD in his IRA there also may be a penalty for cashing in the CD before its maturity date.
Comparisons
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CDs are typically sold by banks, credit unions and other federally insured savings institutions. They are sold in varying denominations and with varying maturity dates. Typically, the larger the investment and longer the maturity date, the higher the interest rate will be. The type and rate of CD usually remains the same whether an investor buys it as part of his IRA or as a standalone investment. There are two major difference in CDs held inside an IRA: 1) the interest will accrue tax deferred and 2) there is a limit to how much can be invested each year in the IRA. There is no limit for CDs held outside of an IRA.
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References
Resources
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