Can I Buy CDs Through My IRA?

A few years ago, certificates of deposit (CDs) were like lone instruments struggling to be heard in the financial orchestra. The average rates of less than 1.00% were drowned out by the noise of inflation. Now, with APYs of 5.00% or more, they're like a full-blown carnival band replete with colorful outfits and an unmissable sound.

Savings have always been an essential part of financial stability. But the current high APYs take us from mere stability into wealth-building territory. Particularly as you'll pay tax on any interest you earn with a CD. That might make you wonder about using a tax-advantaged retirement account like an IRA, to get the best of both worlds.

The good news is that you can combine today's top CD rates with the tax benefits of an IRA. That said, it will usually only make sense if you're close to retirement.

Putting CDs into your IRA

IRAs -- or individual retirement accounts, to give them their full name -- are a tax-advantaged way to save for your old age. They come in several flavors. A traditional IRA lets you reduce your tax bill today. A Roth IRA will reduce your taxes in your twilight years (you contribute after-tax dollars and then make tax-free withdrawals later on).

When you put money into a CD, you commit to leave that money alone for a set period. In exchange, you can earn a fixed interest rate. There are two ways you can put CDs into an IRA:

• Open an IRA CD at a bank: Several banks and credit unions offer IRA CDs. Pay attention to any fees and minimum deposit requirements.
• Put a CD into your brokerage IRA: Some top brokerages will let you buy a brokered CD. This will let you manage your CD alongside your other investments.

One important thing to understand about an IRA is that there are penalties if you want to withdraw that cash before you retire. Outside of a few specific circumstances, if you want to access the cash before you're 59 1/2, you'll have to pay a 10% penalty. Moreover, you'll usually pay a penalty if you want to withdraw money from your CD early.

There's also a limit on the total amount you can put into your IRAs each year. For 2024, under 50s can contribute $7,000, and over 50s can contribute $8,000. So, if you put $4,000 into an IRA CD, you'd only have $3,000 (or $4,000 if you're over 50) left to put into more traditional IRA investments this tax year.

Savings vs. investments

We often use the terms "savings" and "investments" interchangeably. But if you're considering combining CDs and IRAs, it's good to understand the difference.

Savings vehicles -- like CDs and high-yield savings accounts -- are relatively safe ways to earn a guaranteed APY. For example, if you put $4,000 into a 1-year CD that pays 5.00% APY, you will earn $200 in interest. Your cash will be protected by FDIC insurance in case of bank failure. They are excellent for money you know you'll need in the short to medium term.

Investing involves buying assets that you hope will accumulate in value over time. Historically, the average annual return of the S&P 500 (often used as a yardstick for the stock market performance) is almost 8%. That's an average -- there will be good and bad years.

So, if you invest $4,000 in an index fund that tracks the S&P 500, there's no guarantee that you'll earn 8% ($320) in interest in the first year. In fact, you might lose money in the short term. That's no biggie if you still have decades before your retirement because you can ride out any short-term market fluctuations. Investments are great for money you'll need in the long term.

Let's zoom out and see what that longer horizon means in real money. Putting aside the fact that savings rates won't stay this high forever, here's how much $4,000 might accumulate in value at different interest rates:

• After 30 years, a 5% return would give you around $17,000.
• After 30 years, an 8% return would give you over $40,000.

The stock market investment could leave you with more than double the savings account. Moreover, you won't be able to find a 30-year CD that pays a guaranteed 5.00% return. In contrast, history shows it isn't unreasonable to hope for those results from your stock market investments.

Should you put CDs into your IRA?

A lot boils down to your risk tolerance and your timeline. If you are close to retirement and want a relatively safe way to earn a guaranteed interest rate for a set period, a CD IRA could be a good option.

If retirement is still a speck on your horizon, the higher potential rewards of the stock market will likely make more sense. Even a couple of percentage points makes a big difference when compounded over time.