Contributing to an individual retirement account (IRA) is one of the biggest gifts you can give to future you. Possibly the most intimidating aspect of an IRA is deciding how to invest that money for maximum growth. Do you put it toward stocks that you hope will perform well over time? Do you buy exchange-traded funds (ETFs) and mutual funds?

One option that might be flying under your radar, but which offers a chance to consistently grow your IRA in exchange for relatively little risk, is incorporating certificates of deposit (CDs) as part of your retirement savings. Let’s take a look at everything you need to know about IRA CDs—and how to maximize them.

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What is an IRA CD and how does it work?

To understand exactly what an IRA CD is, let’s quickly review what both of these accounts do.

What is a CD?

A CD can be thought of as sort of like a savings account. You deposit money into the bank and promise that you won’t touch it for a specific amount of time—typically between three months and 10 years. 

As a reward for not withdrawing your money for the predetermined amount of time (the CD term), you’ll often receive a generous annual percentage yield, or APY. It may be higher, even, than some of the best high-yield savings accounts offer. It also has the benefit of being set for the full term of the CD, so even if rates fluctuate based on Federal Reserve actions and market factors, the interest you’ll earn on your CD does not change. 

What is an IRA?

An IRA is a personal savings account exclusively for your retirement. Depending on the type of account you open (we’ll cover that in a minute), an IRA can potentially help you to pay fewer taxes today. But note that there are annual limits to how much you can contribute to an IRA:

• $7,000 per year for those under age 50
• $8,000 per year for those age 50 or above

While you can just let the money sit in your account and periodically add to it, that largely defeats the purpose of a retirement account. To make your retirement savings work for you, you should probably invest the funds in things like stocks, bonds, CDs, etc.

Roth vs. traditional: What to know about IRA CDs and taxes

The main difference between a traditional and a Roth IRA CD is when you pay taxes on your contributions:

• Contributions to a traditional IRA CD are tax-deferred. In other words, you won’t pay taxes on that money now—but you’ll pay it later when you withdraw it. In many cases, this may lower your taxable income today.
• Contributions to a Roth IRA CD are taxed now. But you won’t pay taxes when you withdraw your money—no matter how much it’s grown from your investments (like a high-yield certificate of deposit).

To decide which type of IRA CD is best for you, a big factor to consider is whether you suspect you’ll pay more or less taxes when it’s time to withdraw. If you think you’ll be in a lower tax bracket later in life, a traditional IRA is likely the smart choice. But if you think you’ll be in a higher tax bracket, it’s most likely better to pay your taxes now with a Roth IRA.

Do I need to open my IRA CD at the same bank as my IRA?

You aren’t relegated to IRA CDs offered by whichever financial institution holds your existing IRA. You can open an IRA CD with any bank or credit union that offers it.

You can do this in one of two ways:

• Transfer a portion of your IRA to the bank offering your desired IRA CD.
• Open an IRA CD with new money.

Opening an IRA CD at a different bank than your existing IRA will result in having multiple IRA accounts. Just remember that no matter how many IRA accounts you have, in some ways you effectively have a single IRA. That is to say, you’ll still be limited to adding the maximum yearly contribution limits enforced by the IRS across all your IRA accounts.

Pros and cons of IRA CDs

How to choose the best IRA CD for your needs

When shopping for the best IRA CD for your needs, keep in mind these three components.

• APY: Rates can vary wildly, so do some digging to find the banks and credit unions that offer the highest earning rate for your investment. Online banks often tend to offer the most generous APYs.
• Term length: Not all banks offer the same selection of terms. For example, if you only want to commit to an 11-month CD, you’ll have to seek out a bank that offers it.
• Minimum deposit requirements: Some CDs may require no minimum deposit to open an account and earn APY. Others may require thousands of dollars. Choose an account with conditions you’re comfortable with and a minimum deposit that you can comfortably afford

How to maximize an IRA CD

Just because an IRA CD is a relatively straightforward investment doesn’t mean there’s no strategy involved. Here’s how to make the most of this type of valuable retirement account.

Don’t withdraw your IRA CD early

If you remove your money from an IRA CD early (perhaps you’ve discovered a more appealing investment opportunity), you’ll incur heavy penalties—often between 3 and 12 months worth of interest, depending on the term length of your CD.

It’s also worth noting that anyone under age 59½ (with few exceptions) will get dinged with an additional 10% tax when you withdraw money from your IRA CD and don’t reinvest it into your IRA within 60 days.

Build a CD ladder

In short, a CD ladder is a series of open CDs that mature at different times. CD laddering enables you to periodically withdraw a portion of your funds instead of tying up a large sum of money for an extended period of time.

For example, let’s say you want to invest $20,000 into an IRA CD. Instead of throwing the entire sum into a single lengthy CD, you could place:

• $5,000 into a 3-month CD
• $5,000 into a 6-month CD
• $5,000 into a 9-month CD
• $5,000 into a 12-month CD

Once each CD matures, you could reinvest it into a 12-month CD. This way, you’ll have penalty-free access to $5,000 of your money every three months.

Be mindful of FDIC/NCUA coverage limits

Both the Federal Deposit Insurance Corporation (FDIC) and National Credit Union Association (NCUA) insure a maximum of $250,000 in retirement accounts per account holder per bank or credit union.

If you’ve got more than $250,000 in your retirement account, consider spreading that money across multiple financial institutions to protect every shiny red penny.

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The takeaway

An IRA CD is a certificate of deposit that is designed to help grow your retirement from strong interest rates. It’s not uncommon to find IRA CDs that offer an APY of 4.00% or more.

IRA CDs are extremely low-risk, comparatively, as you can lock in a fixed return for months or even years. That will likely make them more appealing to some savers than investing in, say, stocks or bonds. Plus, IRA CDs at FDIC- and NCUA-insured institutions are covered up to $250,000.