CD vs. IRA: What’s the Difference?

What Is a CD?

A CD is a type of savings account generally offered by banks, online banks and credit unions. CDs are time deposits, meaning you agree to leave the money in your account for a specified period of time. In return, you earn a fixed rate of interest, often higher than what you'd earn on a traditional savings account. If you withdraw your money before your CD's term is up, you'll forfeit a portion of your interest as a penalty for early withdrawal.

Learn more: Types of CDs and How They Work

CD embed

Pros and Cons of a CD

A CD earns you higher interest than a regular savings account, but with limited access to your money. Here are a few of the pros and cons of choosing a CD.

Learn more: Are CDs Worth It?

What Is an IRA?

IRAs are tax-advantaged accounts that help you save for retirement. There are different types of IRAs, including SEP-IRAs and SIMPLE accounts for small businesses and self-employed people. For the purposes of this article, we'll focus on the two most common types of IRAs: traditional and Roth IRAs.

Traditional IRAs are funded with pretax dollars. This means you can deduct your contributions from your taxable income. You don't pay taxes on interest or gains as long as investments stay in your IRA account. When you withdraw the money, you'll pay regular income taxes on the full withdrawal.

Roth IRAs are funded with after-tax dollars, so you don't get to deduct contributions on your taxes. However, money in a Roth IRA grows tax-free, and you don't pay taxes on qualified withdrawals.

Learn more: Roth vs. Traditional IRA: What's the Difference?

Pros and Cons of an IRA

IRAs offer tax advantages that incentivize savings and help maximize growth in retirement accounts. As a trade-off, your IRA money isn't easy to access until you reach retirement. Here are a few things to consider.

Learn more: How to Open an IRA

Should I Choose a CD or an IRA?

CDs and IRAs are both good choices for saving, but they work best in different situations. If you're torn between opening an IRA or a CD, think about your goals and your tolerance for risk.

When to Choose a CD

• You want a high APY and guaranteed returns. CDs pay significantly higher interest than regular savings and, in most cases, your APY doesn't change. If your CD has a feature that allows a rate adjustment, it's usually to increase the APY if rates go up during your CD's term.
• You want a safe, no-risk place to keep your money. With a CD, your rate is locked in and your funds are insured against bank failure by the FDIC or NCUA.
• You have mid-range savings goals. CDs aren't ideal for emergency savings because your money isn't easy to access while it's in a CD. That said, you don't have to wait for retirement to access your funds, as you might with an IRA.
• You want to deposit more than the annual contribution limit for IRAs. There's no limit to how much you can put into CDs. If you have more than $250,000 to deposit, you may want to spread your holdings over more than one financial institution.

When to Choose an IRA

• You want tax-advantaged savings for retirement. Tax-deductible contributions, tax-deferred investment growth and/or tax-free withdrawals can all give your retirement savings a boost.
• You have a long investment timeline. Plan on leaving your money in an IRA until you reach age 59½ to avoid early withdrawal penalties. If that's decades away, don't despair. Tax benefits and potential investment returns have the most impact when you save over a long period of time.
• You want higher potential returns to beat inflation. When you're saving for retirement, growth is essential. Although CD rates are reliable, they aren't necessarily going to keep pace with inflation.
• You have an investment strategy. Even if your strategy is to work with a financial advisor or robo-advisor—and not necessarily to become an expert yourself—managing your retirement investments is important to your long-term success.

Tip: If you still can't choose between an IRA and a CD, you might want to consider an IRA CD. It's a CD held within an IRA account, so you get tax benefits and a guaranteed return. However, you'll still be subject to early withdrawal penalties if you withdraw funds before the maturity date and before you're reached age 59½.

Alternatives to CDs and IRAs

CDs and IRAs are only two of the many savings and investing options you have. Though this is far from a comprehensive list, here are a few alternatives to consider if you're ready to start saving your money:

• High-yield savings accounts: A high-yield savings account offers the high APY of a CD without the defined term. High-yield savings accounts are widely available online.
• Money market accounts: Money market accounts also offer high interest rates with the added convenience of checks or debit cards to make payments.
• Health savings accounts: Tax-advantaged health savings accounts (HSAs) allow you to save up for out-of-pocket health care expenses. Caveat: You need a qualifying high-deductible health plan to be eligible for an HSA.
• 529 education plan: A 529 education plan lets you grow your savings tax-deferred. Withdrawals are tax-free as long as the money is used for qualifying education expenses.
• Annuities: Annuities can convert savings into guaranteed payments, often for life. Investment returns are typically tax-deferred, which makes annuities an alternative for retirement savers.
• Taxable investment account: A brokerage account gives you plenty of flexibility to contribute and invest as you want, even if you won't get the tax breaks you would with an IRA or the guaranteed returns of a CD.

Learn more: Places to Save Your Money Based on Your Goals

Frequently Asked Questions

The Bottom Line

CDs and IRAs can both help you reach long-term savings goals. Consider your current circumstances, future goals and interim needs, such as tax savings, guaranteed returns or flexibility, when deciding which type of account is best. Whether you choose a CD, an IRA or another type of savings account, saving for the long term is a worthy goal that can help stabilize your finances and improve your financial outlook.