Certificates of deposit are accounts that pay interest at a fixed rate for a set period of time. Individual Retirement Arrangements are investments that are intended to provide you with income for your retirement years. You can buy a number of different types of investments with your IRA money, including certificates of deposits. There are pros and cons to investing in an IRA, an IRA CD or a non-IRA CD.
When you buy a regular CD from a bank, you have to report the interest that accrues on the account as taxable income. If you buy a CD with IRA money, the taxes are deferred, which means the interest compounds and the CD grows in value more quickly. You pay taxes only when you eventually withdraw money from the IRA. However, if you need to access your IRA money before you reach age 59 1/2, you must pay a 10 percent tax penalty and income tax on the amount withdrawn.
CDs are among the standard products offered by banks and credit unions that are federally insured. If your bank goes bankrupt, the Federal Deposit Insurance Corporation provides you with $250,000 of insurance coverage on your deposit accounts. The National Credit Union Administration insures accounts at credit unions in the same manner. Funds held in an IRA aren't federally insured unless you use those funds to buy standard bank products such as CDs or savings accounts.
When you buy a CD you earn a fixed rate of return on your money. However, if rates are low, inflation may outpace the earnings on your CD. If you invest IRA money in a product other than a CD, you can potentially outpace inflation. Many investors buy mutual funds or stocks with IRA funds as these securities have unlimited growth potential. However, these securities can also lose value, so there are no guaranteed returns, unlike a CD.
IRAs and CDs have different uses and appeal to different people. Conservative investors near retiring often benefit from holding money in CDs or CD IRAs because they don't want to risk principal. Young investors often enjoy significant returns when they invest IRA funds in stocks and mutual funds, but many young investors also set up IRAs only to realize they need their cash back and end up paying tax penalties. Therefore, review your own financial situation before deciding whether CDs or IRAs are best for you.