How a Roth IRA CD Works
You can’t make contributions to a Roth IRA account if you earn $144,000 or more as a single filer or $214,000 or more if married filing jointly in 2022, but these limits tend to increase annually. They go up to $153,000 and $228,000 for the 2023 tax year. The longer the term of the CD, the higher the interest rate it will generally pay. But committing to a five-year Roth IRA CD instead of a one-year CD means that your money is locked up for a longer period of time. You often have to pay a penalty that negates some of the interest earned If you want to withdraw funds before the CD matures. But you might be able to at least withdraw the interest you earn from the CD without paying a penalty if you keep the principal invested.
Example of a Roth IRA CD
A Roth IRA CD essentially combines a Roth IRA with a CD. A Roth IRA is a type of retirement account that allows individuals to contribute post-tax money, which can then grow tax free and be withdrawn tax free if some conditions are met. A certificate of deposit or CD is a type of savings account that provides a predetermined interest rate in exchange for holding a given amount of money in that account for a certain period of time. This might be a few months or several years, depending on the CD. A CD within a Roth IRA structure means that the account holder can receive interest from a CD within the Roth IRA rather than within a regular CD account at a bank. The interest you earn can eventually be withdrawn tax free if you hold a CD within a Roth IRA. The difference between paying taxes on interest from a CD and earning tax-free interest within a Roth IRA might not seem like much, but it can add up. Let’s say that you manage to save $1 million, which you might be able to achieve through a lifetime of saving and investing. Earning just 1% interest per year on that $1 million would result in $10,000 of interest earned. You would be taxed $2,000 on that $10,000 of interest income if you paid taxes at an effective rate of 20% But that full $10,000 in interest could be withdrawn tax free from a Roth IRA CD in retirement if you’re at least 59½ years old and you meet the five-year holding rule for Roth IRAs. So a Roth IRA CD could save you $2,000 in taxes per year in this scenario, compared to taxable interest on a CD that’s held outside of a Roth IRA.
What a Roth IRA CD Means for Individuals
Roth IRA CDs might be an attractive option for some individuals, such as if you’re nearing retirement age or you’re already retired and want to earn some interest without taking on too much risk. Your principal might be at risk if you invested in other assets within your Roth IRA, such as stocks. But you can protect your principal by investing in CDs, including Roth IRA CDs, at financial institutions that are insured by the FDIC. There are still some risks associated with Roth IRA CDs. You might not earn much on your principal compared to other investment opportunities, and you might not have as much liquidity as you’d like. One way to overcome this risk is to use strategies like building CD ladders, where you invest in CDs of varying lengths. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
