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Difference Between IRA and CD

IRA vs CD

There are many saving plans when it comes to retirement. IRA and CD are two very popular plans to save money for the future. Both the plans envisage putting tax free money into savings account which grows till retirement and taxes are applied when the distribution begins. Individual Retirement Account or the IRA is like permanent savings account where one can put a part of his salary without paying any taxes. This is why they are also called tax deferred savings. CD on the other hand is Certificate of Deposit that earns a higher rate of interest than a normal savings account.

IRA

IRA and 401k are probably the most popular saving plans around U.S. IRA can be opened by anyone irrespective of the fact that he is in a job or doing his own business. These plans are a way to encourage people to think about their future and save. With a provision of tax deferment, IRA is indeed very attractive and the person needs to pay taxes only when he starts to get distributions upon the maturity of the plan. Tax advantage is the most attractive feature of an IRA and this is why trillions of dollars are to be found in IRA accounts held across the country. The theory of tax deferment works on the principle that upon retirement, a person has lesser responsibilities and as such he can afford to pay taxes. Even the interest grows tax free and the account has a large amount in a few years. In reality, IRA is a type of an account and not an investment. If you are under fifty, the maximum you can contribute to your IRA is $4000. There is a provision of 10% penalty if you withdraw money from your IRA before you are 59 ½ years of age, but you are exempted under certain cases as when using it for buying a house or for the education of your children.

CD

CD is an instrument for saving for your future and is generally very safe as it is issued by banks. It is also more attractive than a normal savings account as the money earns a higher rate of interest than a normal account. The only drawback with a CD is that banks levy harsh penalties if you withdraw money from your CD before the completion of the term. You can only buy a CD if you have a big amount to put into any bank. Normally, the term of a CD is five years. You need to pay taxes on the interest earned annually.

Difference between IRA and CD

As described above, both IRA and CD are good instruments of saving for your retirement. But there are glaring differences between the two. For one, you can only opt for a CD if you have a lump sum to deposit in a bank, whereas, you can open an IRA account with as little yearly payment as you wish. In an IRA, you need to make yearly payments whereas you make a onetime investment with a CD. CDs are considered to be less risky being issued by banks while IRA’s are a little more risky as they are linked to mutual funds and other securities. As far as advantages are concerned, it is the tax advantage with an IRA that lures people towards it while with a CD it is the stability of the principal amount as well as higher rate of interest that attracts people.

Recap:

Both are individual account and can be opened by anyone

IRA can be opened with as little yearly payment as you can while to open a CD you need a lump sum

IRA has a limit on contribution: $4000, if you are less than 50 years of age or $5000 if you are 50 or above. No limit on CD, it is one time investment.

Maturity period for CD is decided by the bank which can be either 6 months or anything up to 5 years. While for IRA it is fixed. You cannot withdraw before you reach 59 ½ years of age. Withdrawal before that age will result in 10% penalty, provisions are there exemption. The same way, if you do not begin to withdraw minimum distributions by April 1st of the year after you reach age 70 ½, you are subjected to a excise tax of 50% of the minimum distribution.

IRA has the tax advantage; the contribution and the interest earned are tax free until distribution while CD is taxable.

CD is less risky as it is invested with the bank and also the banks give very attractive interest rate for your investment.


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Related posts:

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  2. Difference Between IRA and 401k

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