Individual retirement accounts (IRAs) are designed to help you save money for when you retire. That means they are well suited for long-term savings.
Certificates of deposit (CDs) offer safe returns over long, fixed periods of time.
Given that both IRAs and CDs are good for long-term savings, it’s natural for people to want to save money by opening a CD in an IRA.
Normally, when a CD matures you can take the money back and use it for purchases or other things, but when your CD is in an IRA, there are additional restrictions. Learn about the restrictions on IRA CDs and what happens when an IRA CD reaches maturity.
How an IRA CD Works
An IRA CD is simply a CD put inside of an IRA, which offers certain tax advantages depending on the type of IRA.
CDs are locked in deposits
CDs are a type of deposit account offered by banks. Like a savings account, CDs give you peace of mind that your money is safe while offering interest on the balance of your account. CDs have a few features, including higher interest rates, that differ from savings accounts that make them best suited for long-term savings.
CDs tend to offer more interest than a savings account for one main reason. The money you deposit in a CD is locked into the account for a specified period of time. This period is known as the “term” of the CD. You cannot make changes to a CD, such as withdrawing from or depositing money to it during the CD’s term.
When you open a CD at a bank, you’ll need to decide how much you’d like to deposit in the CD as well as the CD’s term. CD terms usually range from a few months to as many as ten years. Longer terms offer better interest rates, but leave you without access to your cash for a longer period of time.
Over the course of the CD’s term, it will earn interest and the balance will increase.
If you need to make a change to the CD before the term ends, you’ll have to pay an early withdrawal penalty. This penalty is usually equal to a certain number of months’ interest. The longer the CD’s term, the greater the penalty will be. If you withdraw from a CD very early in its life, you might withdraw less than you deposited thanks to the fee.
Early withdrawals from CDs are all or nothing. If you want to withdraw just some of the balance, while leaving the rest in the CD, you’ll need to use the remaining cash to open a new CD. That will reset the term of the CD and give you a new, possibly worse interest rate.
Traditional IRAs give Americans tax benefits as a way to incentivize saving for the future. You are allowed to contribute up to $5,500 per year to an IRA. People who are 50 or older can contribute an extra $1,000 each year.
When you contribute to an IRA, you can deduct the amount of your contributions from your income when you file your taxes. That means that every dollar you save in an IRA takes less than a dollar out of your pocket.
Consider this example:
After accounting for all other deductions, you have a taxable income of $50,000. That means your total federal tax bill will be $8,238.35. If you contribute $5,000 to an IRA, you’ll reduce your taxable income by 10%, to $4,500. Do doing will reduce your tax bill by $1,245.50 to a total of $6,992.85.
Saving $5,000 towards your retirement will cost you less than $4,000 because the government wants to help people have a secure retirement.
There is a tradeoff when you contribute to an IRA. Any amount you contribute cannot be withdrawn from the account until you turn 59½. This restriction is to ensure that people use their IRA as a retirement savings account. If you withdraw money from your IRA before you reach the required age, you will have to pay a 10% penalty on any amount you withdraw.
When you withdraw money from your IRA, you also have to pay tax on the withdrawals, as though they were income.
That’s why IRAs are also called tax-deferred accounts. You delay paying taxes on the money in your IRA until later. Since most people are in a lower tax bracket during retirement than they are during their working years, you’ll pay less tax overall by saving in an IRA.
Roth IRAs offer an alternative to the traditional IRA while still helping people save for retirement.
The limit for IRA contributions is shared between your traditional IRA and Roth IRA. You can contribute only $5,500 combined between all IRAs, regardless of whether they are traditional or Roth.
Where the accounts differ is in the tax treatment of contributions and withdrawals. With a Roth IRA, you pay taxes on the money you contribute to the account. In exchange, when you withdraw money from the account, you pay no taxes, whether you’re withdrawing previous contributions or earnings from the account.
This makes Roth IRAs ideal for people who are in a low tax bracket now, and who expect to be in a higher one in the future.
Another difference is that you can withdraw contributions, but not earnings, from a Roth IRA, penalty-free. The only downside is that you can never replace the money in your IRA, so your retirement account’s balance will be affected.
Traditional IRA Vs. Roth IRA
|Traditional IRA||Roth IRA|
|Contributions may be tax-deductible.||Contributions are not tax-deductible.|
|Pay taxes upon withdrawal.||Earnings can be withdrawn tax-free and without penalties if the funds were in the Roth IRA for 5 years and you've reached age 59 1/2.|
|You must be under age 70 1/2 to contribute.||You can contribute at any age.|
|Required minimum distributions (RMDs) are required starting at age 70 1/2.||No RMDs required.|
What Happens at Maturity
When a CD matures, you are allowed to make changes to it. What exactly happens to your CD varies from bank to bank, but this is how it usually goes.
Some amount of time, usually a few weeks before your CD matures, the bank will inform you of your CD’s approaching maturity date. This gives you some warning so you can plan what you will do when the CD matures.
When the maturity date arrives, you have a few options to choose from. The first is to withdraw some or all of the money from the CD. The second is to add more money to the CD. The third is to roll the CD over into a new CD.
Which choice you go with depends on your needs. If you need cash, withdraw some money from the CD. If you want your savings to grow more, add to the CD or just roll it over into a new one.
Most banks offer a grace period after a CD matures, during which you can make changes to it without penalty. This grace period is typically no longer than ten days. If you take no action, the majority of banks will automatically roll your CD balance into a new CD with the same term as your old one. The interest rate you get is dependent on market rates at the time your CD matures.
If your CD is automatically renewed, you’ll need to wait until the next maturity date to make changes, unless you want to pay an early withdrawal penalty.
What to Do When Your IRA CD Matures
When your IRA CD matures, the most likely case is that you’ll want to let your savings keep earning money.
Move the funds to another IRA account
If you already have an IRA set up somewhere else and would like to move the funds into that account, you may do so. Perhaps, you found a great IRA CD rate at another bank or you simply want to put those funds into something with a higher potential return (and higher risk).
The two common ways to perform this transfer is a direct rollover or a 60-day transfer.
With a direct rollover, you simply instruct the bank with the IRA CD to roll over the funds into another IRA. The money will move directly between the IRAs.
With a 60-day transfer, you will receive the funds from the IRA CD after maturity in the form of a check. You have 60 days to deposit this check into another IRA or you may be subject to taxes and penalties because the IRS would think that you took the money for yourself.
Renew the IRA CD
Another option is to renew the IRA CD at the same bank. More likely than not, the IRA CD is already going to renew automatically for the same maturity period (e.g., a 5-year CD renews into another 5-year CD) unless you've specified otherwise. This is an opportunity to negotiate a bonus CD rate for being a loyal customer.
Set up an IRA CD ladder
If you’re near retirement, you might want to consider setting up an IRA CD ladder. To do this, split your money into amounts equal to how much income you want from your CDs every 3, 6, or 12 months. Then, open a series of CDs with maturity dates that fall every 3, 6, or 12 months. So, if you want to have $3,000 available from your CDs every 3 months, open multiple $3,000 CDs so that one matures every 3 months.
As each CD matures, you can take the money and use it, knowing that the next CD in the ladder will give you some cash in just a few months. This strategy gives you consistent income while letting you earn a good return.
IRAs and CDs can be confusing, but they pair well together for people who want to earn a safe and steady return. Knowing how to handle a CD that matures in an IRA can help you earn the best return possible.