Difference Between IRA CD and CD
October 30th, 2008
The biggest difference between an IRA CD and non-IRA CD is the tax consequences. IRAs (Individual Retirement Accounts) can contain a variety of investments, such as mutual funds, bonds, real estate, and of course CDs.
What is an IRA
Without going into lots of detail about IRAs themselves, they basically are an investment account that grows tax free. You aren’t taxed until you take funds out. Traditional IRAs are made from pre-tax contributions and you can’t access those funds until you are 59 1/2 or older without paying penalties. There are some exceptions, but I don’t want to spend too much time on that. Roth IRA contributions are made after-tax. The account grows tax free, but you can also begin to withdraw fund prior to 59 1/2 without penalty. If you wait until after 59 1/2 you aren’t taxed.
Difference
So back to the difference when it comes to CDs. An IRA CD won’t have any tax consequences until you begin to make withdrawals. With a non-IRA CD, you pay regular income taxes on the interest that is earned, regardless of whether you receive it.
Example
For example, let’s say you open a $100,000 IRA CD for 3-years and a non-IRA CD at 5.00% APY. Over 3-years both CDs will grow to about $115,762.00. However, you will only have to pay taxes on the non-IRA CD. If you are over 59 1/2, at the end of 3-years you can take $5000 out and only owe taxes on that amount. The remaining funds can be left in the CD for another term. With the non-IRA CD you pay taxes on the full $15,762.00 (and generally you pay taxes when the interest is earned, so you would pay taxes on about $5250 per year).
Final Notes
An important note, IRAs have yearly contribution limits. You can’t just one day decide to create a $100,000 IRA CD. Those funds would have to have been accumulating over the years. SEP and SIMPLE IRAs (used by self-employed and small business owners) have a fairly high yearly contribution limit. Traditional and Roth IRAs were $5000 for 2008.
View IRA CD Rates
cd :O)
-- By Chris Duncan
I would appreciate it if you could do a detailed comparative analysis of the tax consqeuences of an IRA-CD vs. a non-IRA-CD. My husband makes enough that we get no tax deduction for what we put in our IRA’s, even though his employer offers no retirement plan (yes, it’s true), so, given that the interest rate is higher on non-IRA CD’s, I’m wondering what we should do. I’d love to know which will turn out to have been the smarter decision in the long run. Thanks.
Will I ever lose my original Credit Union CD investment?
Harry,
I’m not exactly what you are asking. But a federally, NCUA insured credit union follows the same insurance rules that FDIC insured banks do. So an IRA at a federally insured credit union would be insured for up to $250,000.
If the credit union were to fail you would receive your funds back just like you would if it were an FDIC insured bank.
First thing to make sure we are clear on is that IRAs have contribution limits. We don’t deal with new IRAs, but I believe it is around $5000 per individual per year. The self-employeed can open either a SEP or SIMPLE IRA and make larger contributions (although fewer banks seem willing to handle these). But let’s get to the heart of your question.
Let’s say you opened up a $5,000, 5-year IRA CD. Let’s presume a rate of 4.50% APR / 4.59% APY. At the end of 5-years, you will have earned $1,258. If this is a traditional IRA, you won’t pay taxes on the $5000 you put in or the interest earned. If we assume a combined Tax Rate of 25% that is a tax savings of $1,564.74. Of course you can’t touch these funds until you are 59 1/2. If you open up a Roth IRA you pay taxes on the $5,000, but not the earnings and I believe you can actually withdraw from a Roth at any time. You do pay taxes on the withdrawals. The Tax savings on just the interest is $314.00.
If you open up the $5,000 in a non-IRA CDand the rate is higher, say 5.00% APR / 5.11% APY you will earn $1416. You’ll owe $350.00 in taxes so the IRA is better in that respect (by about $200). Also with regular CDs, you actually owe the taxes at the end of each year, regardless of whether you have received the interest or not.
The real power of an IRA is the earnings grow tax free. You only pay taxes after you retire and only on what you withdraw. Also, typically when you retire you are in a lower tax bracket so the tax rate at that point would be lower.
I have to leave a disclaimer. We are not tax professionals, so it is always best to consult one if you have questions.
I hope that heps.
cd :O)
Why is everyone so worried about the economic state of employment? First of all the answer to all there problems is in there own home!!
There Computer!! Everyone has the ability to make money they just don’t excersise it. That’s what I think.