Tips for buying CDs and whether you should own one in an IRA.
Money Girl
304 MG What Is an IRA CD?
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A listener named Evan says, "Your book Money Girl Smart Moves to Grow Rich and Weekly Podcast have helped me get my finances together. But I'm still confused about the IRA CDs that many banks offer. How do they compare to regular IRAs? In this episode, I'll tell you whether an IRA CD should be a part of your retirement plan and give you four tips for buying CDs. An IRA is a special type of account that comes with big tax breaks, which makes it a smart way to accumulate your retirement nest egg. IRAs are available to just about everyone, but many shy away because they don't understand how they work. Here's one of the most important IRA facts to know. An IRA itself is not an investment. Think of an IRA like a basket where you hold different kinds of investments and assets that get favorable tax treatment. The money you put in an IRA can be invested in securities like stocks, bonds, or mutual funds. Or it can be held in non-investment accounts like a savings or CD, which stands for Certificate of Deposit. What you put in an IRA is up to you because you manage every aspect of it. You open the account, send contributions, and choose how to allocate your money. There are different kinds of IRAs for individuals, the self-employed, and business owners. Additionally, there are different types, including traditional IRAs and Roth IRAs. The major difference between a traditional and Roth IRA is how you're taxed. With a traditional IRA, you pay tax in the future when you take withdrawals. With a Roth IRA, on the other hand, you pay tax up front, but enjoy withdrawals in the future that are completely tax-free. The IRA CD that Evan asked about is simply a CD that's owned within either a traditional or a Roth IRA. A CD is a bank product that pays higher interest than a regular savings account because you give up use of your money for a set period of time. For example, you could purchase a $5,000 CD with an annual percentage yield of 1.35% and a term of four years. At the end of the term, or maturity date, the CD would be worth about $5,275. But if you withdraw money from a CD before the term is up, you'll generally get hit with a steep penalty. As I mentioned, a CD is just one type of product you could own in an IRA. A CD can also be owned outside of an IRA, however the earnings would be taxable. Banks promote IRA CDs because they're extremely safe places to stash money for retirement. At FDIC-insured institutions, deposit accounts held in IRAs get up to $250,000 of coverage in the event of a bank failure. However, the FDIC never ensures money you put in investments, such as stocks, bonds, or mutual funds, even if you purchase them through an insured bank. So remember that FDIC insurance only applies to your bank accounts, such as checking, savings, and CDs held inside of or outside of an IRA. The major drawback to owning CDs in an IRA is that your money is locked away earning very low returns. Typically, CD terms range from six months to five years. Plus, you usually have to make a minimum deposit, such as $1,000, to purchase a CD. If you have many years to go before retirement, earning just one or two percent on CDs probably won't be enough to reach your goals. That low rate of growth won't even keep up with inflation, which historically has been about three percent. So unless you're close to retirement, or are already retired, putting a large amount of your retirement savings into CDs is probably much too conservative. Younger investors need at least half of their portfolio invested in stocks or stock funds in order to beat inflation and accumulate enough money to fund a long retirement. If you decide to add CDs to your retirement or non-retirement portfolio, I'll give you four tips to make sure you're getting the best deal. September is a great month for planning. 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Visit Ixcel.com/moneygirl to get the most effective learning program out there at the best price. CD tip number one, use an FDIC insured bank. Not all financial institutions that sell CDs are actually insured by the FDIC. Visit fdic.gov and use a tool called Bank Find to make sure. Additionally, if you buy a CD through a broker, verify that he or she will only place your funds into a CD account at an insured bank. CD tip number two, research early withdrawal penalties. Though you may have the best intentions of keeping a CD until it matures, always know what the early withdrawal penalty would be just in case. If you own a CD inside a traditional IRA, you'd also have to fork over income taxes plus an additional 10% penalty if you withdraw funds before age 59 and a half. CD tip number three, understand the renewal terms. There are many different types of CDs, so review the account agreement carefully. Make sure you know when a CD matures, if it renews automatically, and what the new interest rate would be. CD tip number four, beware of high advertised rates. When you find CD interest rates that are advertised well above the industry averages, be wary. The product may not be a true FDIC insured account, or it could be a marketing ploy to sell you another financial product. To sum up, an IRA can be opened at just about any financial institution, including banks, mutual fund companies, and brokerages. Then it's up to you to decide whether adding CDs to your retirement basket is the right financial move. To read a transcript of this show, connect with me on social media, or submit your money question, go to the Money Girl page at quickanddirtytips.com. This podcast is called "What is an IRA CD?" in its episode number 304. I'm glad you're listening to Ching. That's all for now, courtesy of Money Girl, your guide to a richer life. [MUSIC] H5N1 bird flu is spreading in some animals. 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