Difference Between IRA and Non-IRA CDs

Without going into lots of detail about IRAs (Individual Retirement Accounts) themselves, they basically are an investment account that grows tax free. You aren't taxed until you take funds out. Traditional IRAs are made from pre-tax contributions and you can't access those funds until you are 59 1/2 or older without paying penalties. There are some exceptions, but I don't want to spend too much time on that. Roth IRA contributions are made after-tax. The account grows tax free, but you can also being to withdraw fund prior to 59 1/2 without penalty. If you wait until after 59 1/2 you aren't taxed.

So back to the difference when it comes to CDs. An IRA CD won't have any tax consequences until you begin to make withdrawals. With a non-IRA CD, you pay regular income taxes on the interest that is earned, regardless of whether you receive it.

For example, let's say you open a $250,000 IRA CD for 3-years and a non-IRA CD at 3.00% APY. Over 3-years both CDs will grow to about $273,195.00. However, you will only have to pay taxes on the non-IRA CD. If you are over 59 1/2, at the end of 3-years you can take $5000 out and only owe taxes on that amount. The remaining funds can be left in the CD for another term. With the non-IRA CD you pay taxes on the full $23,185.00 (and generally you pay taxes when the interest is earned, so you would pay taxes on about $5100 per year). If you are in the 25% tax bracket that will be a cost of about $5800. So the IRA gives you some big tax savings.

An important note, IRAs have yearly contribution limits. You can't just one day decide to create a $100,000 IRA CD. Those funds would have to have been accumulating over the years. SEP and SIMPLE IRAs (used by self-employed and small business owners) have a fairly high yearly contribution limit, but are still limited to a percentage of profits that were reported. Traditional and Roth IRAs have a 2010 Contribution limit of $5000.

The real power of an IRA is the earnings grow tax free. You only pay taxes after you retire and only on what you withdraw. Also, typically when you retire you are in a lower tax bracket so the tax rate at that point would be lower.

I have to leave a disclaimer. We are not tax professionals, so it is always best to consult one if you have questions.

Chris Duncan is a FINRA Registered Representative. He specializes in helping clients find the best and highest CD rates nationwide. His clients include individuals, financial institutions, corporations, and public agencies. Visit us for IRA CD Rates.

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