There are lots of reasons why you might want to consider a Roth individual retirement account (Roth IRA) certificate of deposit (CD). For example, you may be planning to tap into your Roth soon, or you already may depend on it for much of your income. Or you may have a really low tolerance for risk.
In these cases, the stock market’s sometimes wild ups and downs may be more than you want to deal with. Of course, in the long run, stocks tend to appreciate, and history shows that investing in them is the most likely path to long-term growth for accounts like a Roth IRA. But you may not have the long run in mind right now, which could make a Roth IRA CD a sensible choice.
Here’s a look at the pros and cons.
- A Roth IRA CD is a certificate of deposit held inside a Roth individual retirement account (Roth IRA). Some banks create CDs expressly for that purpose.
- On the upside, CDs can be a safe and predictable source of income, counterbalancing volatile stocks.
- On the downside, CDs tie up your funds—carrying heavy penalties for withdrawals before maturity—and their interest rates are low and fixed, putting your money at the mercy of inflation.
What Are Roth IRA CDs?
A Roth IRA CD is basically a certificate of deposit—much like the other CDs advertised at your local bank—that’s held inside a Roth IRA. It works like any CD, offering a fixed interest rate over its lifetime, typically anywhere from six months to 10 years. The money is meant to be kept in the CD until maturity; if you withdraw it before then, you’ll usually be hit with penalties.
While you can put any bank’s CD in your Roth IRA, some financial institutions have created special CDs expressly for this purpose, called IRA CDs. These CDs tend to be on the longer side term-wise (a decade or even more), but they offer higher interest rates than you might get elsewhere.
Benefits of Having CDs in Your Roth IRA
There are three main benefits to having CDs in your Roth IRA:
- You get a consistent, predictable return. The annual percentage yield (APY) given for the CD when you buy it is the return that you will receive until it reaches maturity.
- You have an almost complete lack of risk. No investment is 100% safe, but CDs come pretty close. Like most bank accounts, they typically carry Federal Deposit Insurance Corp. (FDIC) insurance (if a CD that you’re considering doesn’t, move on). If your Roth IRA CD is federally insured, you’re covered for up to $250,000 if the financial institution goes under.
- CDs offer higher yields than other insured bank products, such as savings accounts or money market accounts. On April 18, 2022, for example, the average interest rate was 0.17% for a 12-month CD and 0.32% for a 60-month CD vs. 0.06% for a savings account and 0.08% for a money market account, according to the FDIC’s National Rates and Rate Caps report.
Putting one or more CDs in your Roth IRA makes the most sense if you’re very close to retirement or already there.
Downsides to Using Roth IRA CDs
No investment is perfect. Three big disadvantages are associated with putting CDs in your Roth IRA:
- Over the long term, you might miss out on much higher yields elsewhere. CDs pay better than other bank products, but they pay less than many other investment vehicles. As of May 20, 2022, the highest-paying 12-month CDs were offering APYs around 1.25%. In comparison, the average annualized return for the S&P 500 stock market index since its inception in 1926 through Dec. 31, 2021, is 10.49%.
- The second drawback ties in with the first. Since you are locked into a relatively low rate of return, your money may lose ground to inflation. If you invest $100,000 in a CD today earning 1%, and inflation is 3%, then your money will have less buying power when you get it out of the CD than when you put it in. Inflation will have slowly eaten away at your investment principal.
- Your access to your funds is restricted. The penalties for withdrawing money early from your CD don’t much matter if you’re years away from tapping into your Roth or if the account is less than five years old (since you can’t withdraw earnings tax free from it before then, anyway). But if your income needs are in flux, why risk being dinged? After all, the Roth’s flexibility—being able to withdraw your contributions from it at any time—is one of its major selling points.
What is an individual retirement account certificate of deposit (IRA CD)?
While you can buy certificates of deposit (CDs) from just about any bank to put in your Roth or traditional individual retirement account (IRA), some financial institutions create special ones for that purpose and call them IRA CDs. These CDs tend to have longer terms than other CDs—some may be for 10 years or even longer—and generally offer higher interest rates.
Can you use a CD ladder inside a Roth IRA?
Yes. A CD ladder involves dividing a sum of money into equal amounts and investing them in CDs with different maturity dates. Maturity dates for CDs are typically set at three months, six months, one year, five years, or longer—especially for IRA CDs. Creating a CD ladder takes advantage of the various interest rates offered for different time periods and keeps you from being locked in with a low interest rate when rates are rising.
For example, you could take $20,000 and divide it into four $5,000 CDs, each with a different maturity date—one year, two years, three years, and four years. As each CD matures, you reinvest the money in a new four-year CD. This allows you to leverage the higher interest rates of longer-term CDs, while knowing that you’ll always have a CD reaching maturity within a year.
What’s the biggest downside of investing in a CD inside a Roth IRA?
Arguably, the biggest downside is that the value of your CD won’t keep up with inflation—thus, when it reaches maturity, the money that you invested will have less buying power than it did to begin with. There are better ways to build your retirement account if you have a longer window in which it can grow.
The Bottom Line
CDs in a Roth IRA have their pluses. But they’re probably not the best choice if you have decades left for your Roth to grow, since you (1) should be investing more for appreciation than for income and (2) have time to weather the stock market’s ups and downs.
However, if you are at or near retirement age, CDs can be a good, low-risk way to balance out a portion of your investment portfolio—a counterbalance to the stock market’s volatility. You also might consider building a CD ladder within your Roth IRA to help manage your cash flow and ensure that you don’t get locked into a low interest rate for too long.