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IRA CD Advantages And Disadvantages

Saving for retirement has become more important in recent years as expenses continue to increase and the long-term viability of Social Security comes into question. As more individuals take control of their financial futures, 401(k)s and IRAs have become more popular. As their popularity has grown, different types of investment vehicles have become available to benefit from these types of tax deferred accounts. One of these options is called an Individual Retirement Account Certificate of Deposit also known as an IRA CD.

What is an IRA CD?

An Individual Retirement Account based Certificate of Deposit combines one of the most popular types of investments and tax-deferred accounts. An IRA allows individuals to save for retirement on a tax-deferred basis. What this means is that money can be placed into an IRA account where it can grow tax-free for decades then once distributions begin, taxes are applied to the amount distributed in a given year. A Certificate of Deposit gives investors an opportunity to make a decent yield on their savings, normally more than a typical savings account. So the combination of the two allows an increased yield on savings while benefiting from tax free growth as interest payments are rolled back into the principal. Over the decades, reinvesting tax-free interest payments can lead to significant growth and hopefully a more comfortable retirement.

Advantages

One of the primary advantages of an IRA CD is that the funds used are allowed to grow tax-free while also been FDIC insured. For a lot of investors this is an important consideration since other types of investments like stocks and bonds come with the risk of loss in principle. Certificates of Deposit are also more liquid than more traditional types of investment vehicles since the cash is already sitting at your bank or credit union. Should something unfortunate happen, the funds in an IRA CD are readily available normally within 24 hours or less. CD maturities can also be staggered using a ladder system which means partial funds could be available in a more incremental manner avoiding cancellation fees.

Disadvantages

An IRA Certificate of Deposit may not be for every investor however due to certain limitations inherent to this type of investment. Certificates of Deposit are "locked in" for a specific period of time. What this means is that if you buy an 18 month CD and the funds are withdrawn prior to the maturity date there is normally a 10% penalty. Another consideration is that CD's often make substantially less as an investment when compared to more traditional options like stocks and bonds. CD's have interest rates similar to short-term government securities and money market mutual funds which are often in the low single digits. To get a higher rate you have to purchase a longer-term CD, like a five year note, but during that time interest rates could increase substantially leaving you worse off. Being under the umbrella of an IRA also means an additional 10% early disbursement penalty plus applicable income tax reporting. Consider the disadvantages carefully when selecting an IRA CD for investment purposes.