If you’ve already maxed out your retirement contributions through your employer’s plan or you’re not eligible to participate in a plan at work, an individual retirement account (IRA) may be your best bet. IRAs are typically categorized as traditional or Roth accounts but there’s also a third option in the form of an IRA CD. This particular savings vehicle combines certain features of an IRA with a certificate of deposit. There are advantages and disadvantages associated with each option so it’s important to understand how they work when making your choice.
Related: How Should I Save for Retirement?
A traditional IRA allows you to save for retirement on a tax-deferred basis and some or all of the money you put in may be tax-deductible. The IRS caps the amount you can put into a traditional IRA each year. For 2019, the contribution limit is $6,000 plus an additional $1,000 for savers over age 50. The contribution limits are the same in 2020.
Generally, you can open a traditional IRA as long as you’re under age 70 1/2 and have taxable income from working. There are no income restrictions on who can contribute but your income does factor in to what amount of your contributions, if any, you can deduct. Whether or not you’re covered through an employer’s retirement plan also has an impact.
For 2019, single filers covered by an employer’s plan could deduct the full amount of their contribution if their adjusted gross income is $64,000 or less. The AGI limit for married couples filing jointly is $103,000 or less and $123,000 or less if you’re married and file separately. If you’re single and not covered by an employer’s plan then no AGI limit applies but married couples are subject to a cap of $203,000 or less when one spouse is covered through their workplace. In 2020, single filers will need AGIs of $65,000 or less, and married couples filing jointly will need between $104,000 and $124,000.
Generally, you won’t owe taxes on the money in a traditional IRA until you start making withdrawals. Penalty-free withdrawals are only allowed after you reach age 59 1/2. If you take the cash out before then you’ll have to pay taxes on the money along with a 10 percent early withdrawal penalty. Once you turn 70 1/2, you’re required to begin taking minimum distributions or face a much stiffer tax penalty.
The Roth IRA is a relatively new retirement savings vehicle that was introduced as an alternative to the traditional IRA. A Roth IRA is funded with after-tax dollars, which means that you won’t get a deduction for your contributions but you won’t pay any taxes on qualified withdrawals.
The annual contribution limits for a Roth account are the same as a traditional IRA. Unlike a traditional IRA, Roth savers must meet certain income guidelines in order to open this type of account. For 2019, single filers with an adjusted gross income of $122,000 or less are eligible to chip in the full amount. Married couples earning $193,000 or less annually are also able to put money into a Roth IRA. For 2020, single filers with an income of $124,000 or less are eligible. Married couples are eligible as long as they have less than $196,000.
Generally, you can take money out a Roth tax- and penalty-free if your account has been open for at least five years and you’re age 59 1/2 or older. If you withdraw money before age 59 1/2, the earnings are subject to tax and you’ll also get hit with the early withdrawal penalty. There are exceptions to this rule if you’re using the money to purchase a first home, to pay for qualifying medical expenses that exceed 10 percent of your gross income or you become totally and permanently disabled. There are no minimum distribution requirements with a Roth IRA.
When you invest in a certificate of deposit, the money earns interest over a set period time, which may be a few months or a few years depending on the CD. Once the CD matures, you can take the money out or roll it over for a new term. If you cash out a certificate of deposit early you’ll typically have to pay a penalty.
An IRA CD works in a similar way, with your money growing on a tax-deferred basis inside a retirement account. Your initial investment earns a fixed interest rate over a set timeframe and renews automatically. The more money you put in, the higher your rate will be which means a bigger return on your investment. The main difference is that unlike a regular CD, an IRA CD offers certain tax advantages that are associated with a traditional or Roth IRA.
With an IRA CD, you’re subject to the same limitations on contributions and withdrawals as you would be with a traditional or Roth IRA. If you decide to take the money out early the same taxes and penalties would apply. You should also keep in mind that investing in an IRA CD counts towards your total annual IRA contribution limit.
In terms of security, an IRA CD offers a safer investment since your interest rate is not subject to fluctuations in the market. CDs are insured by the FDIC for up to $250,000 so if your bank goes under you’ll be protected up to the federal coverage limits.
The Bottom Line
Choosing the right retirement savings vehicle requires a careful evaluation of your income, current tax situation and your long-term outlook. If you’re looking for a tax break now and you expect your tax bracket to be lower in the future then a traditional IRA may make sense. If you’re only interested in supplementing an employer’s plan without any immediate tax benefit, you may be better off with a Roth. The IRA CD offers a safer investment for those with a low risk tolerance. Ultimately, the option you choose should reflect your comfort level and overall savings goals.
If this all seems overwhelming, don’t hesitate to work with a financial advisor to get your retirement savings on track. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to three fiduciaries who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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