With Rates at 5.15%, Should You Put CDs in Your Roth IRA?

High interest rates are good news for CD investors. The best certificates of deposit (CDs) APYs are above 5% right now, which is a pretty sweet deal if you can afford to lock up your money for the full term. The return is essentially guaranteed since it's not subject to stock market fluctuations, and both your deposits and returns are protected by FDIC insurance.

Given the appeal of CDs right now, you may be wondering: Should I put some of my Roth IRA money in CDs? Here's why you may want to think twice before doing so.

Why you probably shouldn't put CDs in your Roth IRA

A Roth IRA is a type of individual retirement account. You can invest the money you deposit in the account in almost anything you choose, including stocks, bonds, mutual funds, exchange-traded funds, and CDs.

It's a powerful retirement savings vehicle because it offers important tax advantages. You don't get an upfront tax break for contributions, but if you follow certain rules, all your withdrawals will be tax-free in retirement.

In other words, say you use your Roth IRA money to buy the next Apple or Amazon when it's selling at $10 a share. If the stock price balloons to $1,000 a share, you won't owe a penny of taxes when you sell the stock and withdraw your money as long as you're 59 1/2 and you've held the account for at least five years.

The enormous potential tax savings makes a Roth IRA best for investments with high potential growth, and CDs don't exactly fit the bill. Interest on a CD is taxable as ordinary income, but the potential tax savings from using Roth IRA money for CDs typically isn't worth it.

Consider that the best 5-year CD rates are currently around 4%. (Shorter-term CDs are currently yielding slightly more, with top CD rates at 5.15%, but that's because financial institutions don't want to commit to a higher rate in the long term in case interest rates drop.)

By comparison, the S&P 500 index has average annual returns of about 10%. So if you invested in a low-cost S&P 500 index fund, you'd expect your money to grow by over 60% over five years -- and all of that growth can be yours tax-free if you held those funds in a Roth IRA.

It pays to be selective about what investments you choose for your Roth IRA because the account has annual contribution limits. In 2024, you can only contribute $7,000 if you're 49 or younger, or $8,000 if you're 50 or older.

Should you invest in CDs right now?

You may want to consider investing in CDs right now while interest rates are high. Here are some situations where putting money in a CD makes sense:

• You're getting close to retirement: If you're planning to retire in the next couple of years, you typically want to shift some money from higher-growth assets like stocks into fixed-income investments, such as bonds and CDs, so that you have some insulation from stock market volatility. In that case, you may want to put some retirement money in CDs, but check in with a financial advisor to discuss the pros and cons.
• You can afford to lock up your money for a while. When you put money in a CD, you'll pay a penalty if you cash out before it matures. That makes CDs a decent choice when you want to earn a guaranteed rate on your savings, but you generally want to avoid putting your emergency fund in CDs.

While CDs aren't right for everyone, most people can benefit from a Roth IRA. If you're not taking advantage of the potential tax savings, consider opening one. Many of the best Roth IRA brokers have low fees and minimal upfront deposit requirements, making it easy for you to start investing today.