Should You Open a CD in Your IRA?

If it seems like just about everyone you know is rushing to open a CD, there's a reason for that. CD rates are at their highest level in years following a string of interest rate hikes from the Federal Reserve. And while you shouldn't expect the same returns from CDs as you might get from a stock portfolio, with the former, you're eliminating the risk that comes with investing in the market.

CD deposits are protected for up to $250,000 per person at FDIC-insured banks ($500,000 for joint accounts). So if you put $5,000 into a CD, you're guaranteed not to lose your $5,000 even if your bank fails. With stocks, there's always the risk of investing $5,000 and having it eventually be worth a lot less -- or even $0. 

Given what CDs are paying today, you may be inclined to open a CD in your IRA. Doing so has its advantages. But whether it's the right strategy for you depends on where you are in your savings window.

The upside of opening a CD in your IRA

The fact that you can earn risk-free interest with a CD is a good thing. But that interest is also income the IRS gets to tax you on. And interest income is taxed as ordinary income, so it's subject to the same tax rate as your highest dollars of earnings.

IRAs, on the other hand, give you the benefit of tax-deferred growth. So when you earn interest on CDs in an IRA, you don't have to pay taxes on that money right away. Rather, you pay taxes when you take withdrawals from your account.

The downside of opening a CD in your IRA

CDs today may be paying around 5% -- or in some cases, a little more. But the stock market's average annual return over the past 50 years has been 10%. So tying up retirement savings in a CD could mean stunting your nest egg's growth.

Should you open a CD in your IRA?

Whether it's a good idea to put some of your IRA funds into a CD really depends on where you are in your savings journey. Those near retirement are often advised to shift toward safer investments and away from stocks. So if you plan to wrap up your career in a few years, it could be a good idea to put some of your IRA into a CD, or a series of CDs. 

In fact, you may want to open a 48- or 60-month CD instead of a shorter-term one if you're getting close to retirement. Though you generally won't get as high an interest rate as you can with a 1-year CD, or a term closer to 12 months, you'll lock in a reasonably strong rate for a longer period.

On the other hand, if you're decades away from retirement, you're generally better off sticking with stocks in your IRA. Let's say you're 30 and won't retire for another 35 years. If you were to earn 5% on $5,000 of your IRA funds, in 35 years, you'd grow that sum to about $27,600. With a 10% return, which is what you might get with stocks, you'd end up growing your $5,000 into about $140,500 instead.

It's also important to recognize that because today's CD rates aren't the norm, opening CDs in an IRA may not be a great long-term strategy. It's one thing to open a single 1-year CD in your IRA now to get a risk-free 5% or so for a year. But in time, CD rates are likely to drop. And once that happens, the gap between what a CD might pay you versus a stock portfolio is likely to widen. 

As such, CDs could be a decent choice for older savers right now within an IRA. But they're generally not the best option for an IRA in general.