Difference Between a CD, IRA and Roth IRAs
When saving for the golden years, consumers have multiple investment vehicles available to them, including CDs (certificates of deposit) and IRAs (individual retirement accounts). Regular, or traditional, IRAs and Roth IRAs are intended primarily as ways to fund retirement. While you can use a CD for retirement, it is almost always a conservative investment that does not reap the tax benefits of both types of IRAs.
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Certificate of Deposit
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CDs are typically straightforward investments. Money is invested in a CD for a fixed period of time, between three months and five years. In return, the bank or other financial institution issuing the CD offers the investor a higher rate of return than with similar investments without a time commitment. Typically, the longer the length of the CD, the higher the rate of return. The drawback with CDs is that any early withdrawals are subject to penalties which vary from product to product.
Traditional IRA
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With a traditional IRA, the federal government allows investors to make tax-deductible contributions, up to a yearly limit. For example, if you invest $2,000 in a traditional IRA over the course of the tax year, you can deduct that amount from your taxable income. Once you reach age-59-1/2, the Internal Revenue Service (IRS) permits you to make withdrawals from your traditional IRA account; these are subject to regular income tax at the time of distribution.
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Roth IRA
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When it comes to taxes, a Roth IRA is the inverse of a traditional IRA. With a Roth, the contributions are made with after-tax money. Roth IRA investments cannot be deducted from your income. However, when you begin withdrawing Roth IRA proceeds, beginning at age-59-1/2, the entire amount, including earnings on contributions, is not subject to income tax. Unlike a traditional IRA, you must have earned income from a job in order to contribute to a Roth IRA account.
Expert Insight: CDs
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In order to take advantage of higher rates yet not have too much money tied up for too long in a CD, Kiplinger suggests a strategy known as "staggering" or "laddering." If you have $2,000 to put into CDs, for instance, you can divide it up equally into three-month, six-month, one-year and two-year products. When the three-month CD expires, take the proceeds and put them into a six-month CD. Repeat the process with the six-month CD so that you will always have a CD maturing within three months.
Expert Insight: IRAs
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According to the IRS, you can count contributions made to an IRA between January 1 and April 15, in either the current or previous tax year. While this may impact Roth IRAs in terms of yearly contribution limits, which vary from year to year, the consideration applies more to traditional IRAs. If you face a large tax bill, making a late traditional IRA contribution for the previous tax year can lower a looming tax bill.
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References
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