IRA vs. Certificate of Deposit: What's the Difference?

One is a retirement account and the other a short-term investment

Individual Retirement Accounts (IRAs) vs. Certificates of Deposit (CDs): An Overview

An individual retirement account (IRA) and a certificate of deposit (CD) are two types of savings accounts that can be obtained at financial institutions, including banks. While they are designed to help people save, they are inherently different. An IRA is designed for long-term investing for retirement income while a CD is considered a short-term savings account.

An IRA is a retirement investment account that has tax advantages to the saver and restrictions on its use before reaching retirement age. The account holder may contribute to it every year, up to limits set by the Internal Revenue Service (IRS). A CD is, essentially, a type of savings account. The account holder gets a little more interest in return for keeping the money in the account for some period of time from six months to five years.

The owners of IRA accounts can choose to invest the money in any of a large assortment of stocks, bonds, exchange-traded funds (ETFs), and mutual funds. In fact, they can choose to invest some of it in CDs.

Key Takeaways

  • Individual retirement accounts and certificates of deposit provide investors with different savings opportunities.
  • An IRA is a tax-advantaged retirement account that allows the account holder to keep it for decades and add to it from year to year.
  • A CD is a type of savings account that gets a slightly higher interest rate than a regular savings account in return for a commitment to keep the money in for a set term.
  • Both types of accounts can be opened at a bank, a brokerage, or another financial institution.
  • IRAs give investors certain tax breaks, depending on the type, while CD holders must report any interest income above $10.

Individual Retirement Accounts (IRAs)

The IRA was created by the federal government to encourage Americans to save money towards their retirement years. The account holder may make annual contributions for decades as the balance grows. After age 59 1/2, the account holder may begin withdrawing the money (and, if it's a traditional IRA, paying the taxes due on the withdrawals).

The IRS sets eligibility requirements, limits on how and when you can make contributions, as well as the amount of the required minimum distributions (RMDs) that you must start taking from your traditional IRA account by April 1 of the year after you reach age 72. The IRS also determines the tax treatment for the various types of IRA accounts.

IRA account holders choose the investments in their accounts. The returns depend on the performance of the investments held in the IRA account. The maximum you can contribute to an IRA in 2021 and 2022 is $6,000 ($7,000 if you are age 50 or older) each year or your annual taxable income, whichever is lower.

Traditional IRA regulations allow you to take early withdrawals (before age 59½) under certain circumstances. Roth IRA regulations are more flexible, allowing you to withdraw contributions at any time as long as you do not withdraw any of the earnings (otherwise penalties apply).

CDs are usually insured by the FDIC for up to $250,000. IRAs are not.

Certificates of Deposit

A certificate of deposit is a savings instrument that is issued and administered by banks, credit unions, and brokers. CDs are considered one of the safest investments available. A CD is as safe as a bank savings account, but it pays a little more interest in return for a commitment to keep the money in the bank for a set period of time.

These types of accounts are safer than stocks or even bonds but they do offer lower returns. They are insured by the Federal Deposit Insurance Corporation (FDIC) if they are issued by an FDIC-insured bank.

CDs pay a specified interest rate over a defined period and repay your principal at maturity. Therefore, CD owners know going in how much they will earn over the life of a CD. They can be issued in any denomination, and their maturities typically range from one month to five years or longer. However, if you make a withdrawal from a CD before its maturity date, you will owe a penalty.

The IRS sets limits on who can contribute to a Roth IRA. You can't contribute to one if you earn more than $140,000 in 2021 and $144,000 in 2022 if you are single. If you married and file jointly, your income limit is capped at $208,000 in 2021 and $214,000 in 2022.

Key Differences

Types of IRAs and CDs

Investors have different IRA and CD options available to them when it comes time to invest. There are generally four different IRAs that investors can choose from, depending on their situation:

  • Traditional IRAs allow investors to make tax-deductible contributions.
  • Roth IRAs give investors tax-free income
  • SEP IRAs let employers (usually small businesses or self-employed individuals) make contributions to a traditional IRA for an employee
  • SIMPLE IRAs offer small business employers and employees to invest matching contributions to a retirement plan as long as they have no other retirement savings plan set up

CDs also come in many shapes and sizes. Here are some of the most common ones you can find:

  • Standard or traditional CDs come with fixed/locked-in interest rates, minimum deposit requirements, and fixed terms. Early withdrawals come with a penalty.
  • High-yield CDs provide better rates than standard or traditional CDs.
  • Bump-up CDs allow investors to get better rates (usually once per CD term) if their institution raises interest rates.
  • No-penalty CDs come with lower interest rates but give investors the option of withdrawing their money early.

Tax Implications

Another key difference between IRAs and CDs is how they are treated for tax purposes. IRAs provide certain tax breaks to investors, depending on the vehicle they choose.

Contributions made to a traditional IRA are tax-deductible, as long as you meet the income and tax-filing status requirements. This means that you contribute pretax income that grows tax-free. You only start paying taxes once you start making withdrawals. Roth IRAs work in the opposite way—you pay taxes on the contributions but earn tax-free income upon retirement.

CDs, on the other hand, come with no tax breaks. But you may owe taxes on any interest income you earn. Your institution will send you a Form 1099-INT for any interest you earn on your investment. The IRS requires that you report any interest income that exceeds $10. Keep in mind that you aren't required to pay taxes on your principal balance.

Advisor Insight

Rebecca Dawson
President - Dawson Capital, San Mateo, CA

IRAs are available to anyone of any age as long as you have earned income. You can invest the funds in your IRA in, but not limited to, stocks, bonds, mutual funds, and CDs.

An IRA is an account that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis, depending on the type of IRA.

A CD is a type of fixed-interest-rate deposit over a set period of time. When that term ends, you can withdraw your money or roll it into another CD.

CDs offer a low return but are among the safest investments a person can make. The interest rate is determined ahead of time. CD owners are guaranteed to get back what they invested, plus interest, once the CD matures. What’s more, if the bank goes under, their deposit is likely insured by the FDIC for up to $250,000.

Article Sources
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  1. Internal Revenue Service. "Publication 590-A: Contributions to Individual Retirement Arrangements," Page 6.

  2. Internal Revenue Service. "Traditional and Roth IRAs."

  3. Internal Revenue Service. "Retirement Topics—IRA Contribution Limits."

  4. Federal Deposit Insurance Corporation. "Are My Deposit Accounts Insured by the FDIC?"

  5. Federal Deposit Insurance Corporation. "6500—Consumer Protection."

  6. Internal Revenue Service. "Amount of Roth IRA Contributions That You Can Make For 2021."

  7. Internal Revenue Service. "Amount of Roth IRA Contributions That You Can Make for 2022."

  8. U.S. Securities and Exchange Commission. "Individual Retirement Accounts (IRAs)."

  9. Internal Revenue Service. "Publication 550 (2020), Investment Income and Expenses."

  10. Internal Revenue Service. "Topic No. 403 Interest Received."

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