How Does an IRA Money Market Account Work?

by Patrick Gleeson, Ph. D., Registered Investment Adv ; Updated July 27, 2017

A money market account is not all that different from a savings account. Both are bank accounts in which you deposit funds, and both are insured by the Federal Deposit Insurance Corporation, or FDIC. Both types offer investors a fixed return on their investment and the right to withdraw money at any time. Money market accounts, or MMAs, usually pay slightly higher interest rates, may offer optional checking and often require a higher initial deposit.

A money market fund, or MMF, is a related account type offered by your broker.

IRA Money Market Accounts vs. IRA Money Market Funds

If you set up an individual retirement account-based MMA at your bank, the funds you put into the account are insured for up to $250,000 by the FDIC. Investors with more than $250,000 can set up another IRA money market account at a second bank. You can even have two accounts at the same bank, each insured for $250,000 if, for example, one's a joint account and the other is in the name of a single party. There's no absolute limit on your FDIC insurance, as long as you don't hold more than $250,000 in one name in a single institution.

The bank invests your money in short-term Treasuries issued by the federal government and in low-risk commercial paper -- short term notes issued by major U.S. businesses, such as Ford Motor Company. The FDIC notes that no depositor has ever lost money in an FDIC-insured account

An IRA MMF is also a low-risk account but with some differences. Although investors commonly call both types "money market accounts," which can lead to thinking they are the same, cash held in an IRA at your brokerage is not held in a money market account at all. In reality, it's money invested in a mutual fund. An MMF also invests in short-term Treasuries and in commercial paper, but MMFs are not insured by the FDIC. Instead, they're insured by the Securities Investor Protection Corporation (SIPC), a nonprofit corporation funded by broker-dealers.

The risks in both MMAs and MMFs are extremely low, although arguably the risk in an MMF is slightly higher because even broker-dealers with assets running in the trillions can't match the assets of the federal government.

Insurance Coverage Differs

The biggest difference is the insurance coverage. Total assets in your IRA are insured for up to $500,000 by the SIPC, twice the insurance offered for a single FDIC-insured account. But cash in the account is only insured up to $100,000. If you had $500,000 in the account in cash, you're only covered for $100,000 of that. If you had $500,000 in equities, you'd be repaid in full.

Inflation Risk in IRA Money Market Accounts

The other risk with both MMAs and MMFs is the loss of buying power from inflation. Studies show that investors underestimate this risk.

In every economic sphere, there is a relationship between risk and reward. Investors in risky ventures expect to be amply rewarded for accepting greater risk; investors in safer adventures expect -- or ought to expect -- lower returns. Because money market accounts of both types are low-risk investments relative to most others, they traditionally pay less. In 2009, for example, 30-day money market funds had average annualized returns of only 0.16 percent. That same year, the Consumer Price Index, which expresses inflation, rose 2.27 percent. Investments in money market funds in 2009 had substantially negative real returns.

About the Author

Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.