What's the difference between an individual retirement account (IRA) and a certificate of deposit (CD)?
An individual retirement account (IRA) can be thought of as an individual savings account that has tax benefits. You open an IRA for yourself (that's why it's called an individual retirement account) and if you have a spouse, you'll each have a separate account.
An important distinction to make is that an IRA is not an investment itself. It is an account where you keep investments such as stocks, bonds and mutual funds. You get to choose the investments in the account and can change the investments if you wish. Your return depends on the performance of the investments held in the IRA account. An IRA continues to accumulate contributions and interest until you reach retirement age, meaning you could have an IRA for decades before making any withdrawals.
IRAs are defined and regulated by the IRS, which sets eligibility requirements, limits on how and when you can make contributions, take distributions and determines the tax treatment for the various types of IRA accounts. For example, as of 2018, the maximum you can contribute each year to your traditional or Roth IRA is $5,500 ($6,500 if you're age 50 or older).
Traditional IRA regulations allow you to take early withdrawals (before age 59 1/2) under certain circumstances. Roth IRA regulations are more flexible. If you have a Roth, you can withdraw contributions at any time, but will pay a penalty if you withdraw any earnings before age 59 1/2. There are exceptions to this rule.
Good question, sometimes there is confusion between the two. I remember years ago in my banking days, some customers would ask "What's your IRA paying?"...more than likely thinking in terms of a CD, so you aren't alone.
A CD stands for certificate of deposit. With a CD, you deposit a certain amount of money for a specified period of time and will earn a specified amount of interest. For example, you could deposit $20,000 into a 2 yr CD for 0.25% APY interest (yes, you are reading this right, you would recieve 1/4 of 1% on a 2 yr CD, this is an actual current rate being offered at at major bank). Think of a CD as a small loan to a bank. In return for you "loaning" the bank money, they are going to pay you interest , and at the end of the term, you will get your money back. The longer the CD term and the larger the deposit, the "higher" the return.
As I'm sure other respondents before me have shared, an IRA stands for Individual Retirement Account. It is and account that allows you to contribute earned income so that you can invest the money and it can grow tax-deffered or tax free, depending on the type of IRA chosen. Think of an IRA as an umbrella, and underneath that umbrella you can invest your contributions into things like stocks, mutual funds, ETFs, and CDs, as discussed above. However, the IRA (umbrella) is protecting your your money, your investments (not from rain..:)) from being taxed during your working years. This allows your saving to grow faster because it's not being taxed. Once you retire and you start withdrawing the money you saved to live on, it's no longer prottected in the umbrella, you start paying your taxes on that income.
In return for the protection the IRA is providing, Uncle Sam limits how much you can contribute per year, $5500 limit if you are age 50 or younger ($6500 if you are older than 50). I hope this helps, thank you.
An IRA is an account type and a CD is a type of investment. You could actually hold a CD inside of an IRA. A CD is a fixed income investment where you use capital to buy the CD and the CD pays you interest over a specified amount of time and then returns your principal to you. If you hold a CD within an IRA, none of the income you receive will be taxable in the year you receive it. However, once you take a withdrawal from the IRA, all your contributions and growth through interest, dividends, and capital gains will be taxed at ordinary income rates.
These are two distinctly different terms. An individual retirement account (IRA) is a tax-deferred account to which contributions may be made over time and allowed to grow without annual tax liability until funds are withdrawn from the account. Funds may be withdrawn after the age of 59 1/2 and taxes are payable on the amounts that are withdrawn. Funds must be withdrawn annually after the age of 70 1/2 at a percentage based on life expectancy. Funds may be withdrawn before 59 1/2, but they will be subject to a penalty of 10% in addition to the applicable tax rate.
A certificate of deposit represents funds deposited with a financial institution for a specified period of time and for a specified rate of interest. Unlike an IRA, the interest paid on the CD is taxable for the year in which it is earned.
An Individual Retirement Account (IRA) is a tax deferred account available for anyone of any age as long as you have earned income. Once you open your account, you may invest the funds in your IRA in, but not limited to stocks, bonds, mutual funds, and/or even CDs. An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis. A traditional IRA is tax deferred which you make contributions with money you may be able to deduct on your tax return, and any earnings can potentially grow tax-deferred until you withdraw them in retirement.
A Certificate of Deposit (CD) is a type of fixed interest rate deposit over a specified period of time. When that term ends, you can withdraw your money or roll it into another CD. Withdrawing before maturity can result in a penalty. It is low risk and low return. CDs are among the safest investment a person can make. The interest rate is determined ahead of time, and you’re guaranteed to get back what you put in, plus interest once the CD matures. What’s more, if the bank fails or goes under, your deposit is most probably insured by the FDIC for up to $250,000.
The difference being that an IRA is a type of account in which you may leave in cash or invest in differing securities or CDs. Whereas a CD is a time deposit at a financial institution which may be bought in either a qualified (IRA) account or a non qualified (cash) account.
An Individual Retirement Account or IRA is a type of tax deferred retirement account. It is a receptacle for holding assets from stocks, bonds, mutual funds, and even a CD if you wanted. A Certificate of Deposit or CD is a "time deposit" by a bank or credit unions and normally has FDIC insurance. So, one is a type of account and the other is a type of investment with various maturity dates depending on which you chose. They are generally 6 month, 1 year, 2 year, and up to 5 years, but can go longer. It is not what I would recommend in this low interest rate environment unless you are putting a small portion of your portfolio into CDs as your "safe money."
Hope this helps, Dan Stewart CFA®