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Both certificates of deposit (CDs) and individual retirement accounts (IRAs) can play a valuable role in your savings and investment strategy. But depending on your goals, one might serve you better than the other.
It’s also possible that both CDs and IRAs have a place in your financial strategy. Understanding the difference between the two will help you figure out when to use each one.
CD vs. IRA Overview
CDs and IRAs both help you save and grow your money. However, one is a short-term savings tool, and one is an investment account.
A CD is a type of savings account. With a CD, you make an initial deposit and agree to leave it in the account for a specified period of time in exchange for guaranteed interest earnings. When the time is up, you get to collect your principal and interest earnings. CDs are low-risk investments that offer modest returns—higher than a savings account, but often not enough to outpace inflation.
An IRA is an investment account designed to help you save for retirement. It incentivizes retirement savings by offering tax advantages, which vary by type of IRA. IRAs act as investment vehicles—meaning you can use the funds inside them to invest in various securities and savings products. Growth potential and risk level will vary depending on what you invest in.
What Is a CD?
A CD is a type of savings account you can open at a bank, credit union or brokerage. CDs typically pay higher interest rates than you’d get on a traditional savings account in exchange for leaving your money untouched for a set period of time.
When you open a CD, you make an initial deposit and agree to an interest rate and term. When the term is up, you can withdraw your principal and interest or reinvest it for another term. However, you’ll face an early withdrawal penalty if you touch your money before your CD reaches maturity.
CDs are low-risk investments. That’s because in most cases, CDs are insured by the FDIC or NCUA. There are exceptions, including CDs opened at a brokerage.
CDs vary by term, minimum deposit requirement and interest rate. You can find CDs with terms ranging from one month to up to 10 years. Interest rates vary too, so it’s important to research the best CD rates before opening an account.
CDs are a useful investment tool when it comes to saving for short-term goals. Low risk and a guaranteed return make it easy to fit CDs into your savings plans. But CDs aren’t the best investment for long-term savings, because the returns don’t compare to those you tend to see in the stock market over the long run.
How To Get a CD
Shop around for CDs with competitive interest rates. If you want to open a CD at a credit union, you have to be a member.
Decide what term length makes sense for your goals. Make sure you choose a term that won’t keep your money tied up longer than you can afford. For example, if you want to use your initial deposit and earnings to pay for wedding expenses that are eight months away, don’t lock up your money in a one-year CD.
When you decide on a CD, read the account’s policies on minimum deposit requirements and withdrawal fees. When you’re ready to open the account, you can usually do so online or in person. When you apply, you may be given the choice to receive your interest earnings incrementally throughout the term or in one lump sum at maturity. Finally, you’ll fund your CD.
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What Is an IRA?
An IRA is an investment account designed to help individuals save for retirement by providing tax advantages to incentivize contributions. Unlike retirement accounts opened at your place of employment—like a 401(k) or 403(b)—anyone who earns an income or is married to someone with an earned income can open an IRA.
While an IRA is an investment account, it’s not an investment itself. Instead, you fund your IRA with either pre- or post-tax dollars—depending on the type of IRA. Then, you can buy various investments like stocks, bonds or even IRA CDs with the money in your account.
There are different types of IRAs, each with different rules and tax advantages set by the IRS. The two most common are the traditional IRA and the Roth IRA. With a traditional IRA, you contribute pre-tax dollars, but you’ll pay taxes when you make withdrawals in retirement. On the other hand, you contribute to a Roth IRA with after-tax dollars, but you won’t pay taxes when you make withdrawals.
As of 2023, the yearly contribution limit for both of these accounts is $6,500 until you reach age 50—then the limit jumps to $7,500. Generally, you can start withdrawing money from an IRA at age 59½ without penalty, though there are exceptions.
In addition to contribution limits, the IRS sets rules around required minimum distributions (RMDs), which are withdrawals you must start making at a certain age.
How To Get an IRA
Like CDs, you can usually open an IRA online or in person through a brokerage, bank or credit union. The first step is to decide which type of IRA you want to open. Traditional and Roth IRAs are common choices. But depending on your circ*mstances, you may want to look into other types of IRAs, including:
- Simplified employee pension (SEP) IRA: designed for small business owners and the self-employed
- Spousal IRA: designed for spouses without an earned income
- Savings Incentive Match Plan for Employers (SIMPLE) IRA: designed for small business owners
- Self-directed IRA: designed for those who want to invest in nontraditional assets
You’ll also want to consider how active of an investor you want to be. If you want to be hands-off, a robo-advisor can choose investments for you based on your goals.
Once you know which type of IRA account you want to open and with which institution, you’ll need to make an initial deposit. Depending on where you open the account, you’ll need to reach a minimum balance before you can start investing the money in your IRA.
CD vs. IRA
When comparing an IRA vs. CD, you’ll notice several differences and similarities between the two.
Similarities of CDs and IRAs
- CDs and IRAs have constraints over when you can make withdrawals without penalty.
- CDs and IRAs sometimes have minimum investment requirements.
- CDs and IRAs allow you to grow your money over a period of time.
Differences Between CDs and IRAs
- CD deposit limits vary by institution, while IRA contribution limits are set by the IRS.
- IRAs offer tax advantages, while CDs don’t.
- Most CDs only allow one initial deposit, but you can make multiple contributions to an IRA up to the yearly contribution limit.
- CDs are insured and provide a guaranteed return. IRA returns are variable and depend on the investments within the account.
- IRAs are designed for retirement savings, and CDs are designed for shorter-term savings goals.
- There are no income limits for investing with CDs, but there are for some types of IRAs.
| Certificates of Deposit (CDs) | Individual Retirement Accounts (IRAs) | |
|---|---|---|
Returns | Guaranteed, relatively low | Not guaranteed, variable, depends on how the money in the IRA is invested |
Usually insured by the FDIC or NCUA for up to $250,000 | Deposit accounts held in IRA at FDIC- or NCUA-insured institutions are covered up to $250,000; non-bank securities held in IRA are not | |
Withdrawals | Can typically only make penalty-free withdrawals at maturity | Generally can’t make penalty-free withdrawals until age 59½, but there are exceptions |
Minimums | Varies widely, usually $500 to $1,000 | Varies by institution |
Risk | Low risk | Depends on how the money in IRA is invested |
Contribution limits | Varies by institution | Limits set by IRS. As of 2023, annual limits are $6,500 for those under 50 and $7,500 for those 50 and older |
Fees | Usually none except early withdrawal penalty | Varies by institution |
Tax advantages | No | Yes, varies by type of IRA |
Income limits | No | Yes, for some types of IRAs |
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Bottom Line: Is an IRA or CD Better?
When comparing CDs vs. IRAs, one isn’t better than the other. Both are valuable investment vehicles to help you save money for the future. CDs are better if you’re saving for short-term goals. An IRA, on the other hand, is best for investing over decades. In the end, you can use both CDs and IRAs to serve different purposes in your overall financial strategy.
