IRA vs CD — what's the difference and which one should you pick? (2024)

Choosing between a certificate of deposit (CD) and an individual retirement account (IRA) boils down to your plans for the money. CDs offer stability for short-term goals with fixed APYs while IRAs allow you to invest in the stock market for long-term retirement savings. Learn how to use both account types to meet your financial goals.

A certificate of deposit is an interest-bearing account offered by banks and credit unions where you place your money. Unlike savings accounts, most CDs require you to lock away your funds for a certain period (called the CD's term). Because of that, the APY of your CD typically won't change during the CD's term, no matter what happens with interest rates in the wider market. When interest rates are high (and you expect they may fall soon), it can be a good idea to put some money in a CD to lock in those high rates.

Alliant Credit Union, our top pick for CD rates, offers CDs with up to 5.20% APY with terms ranging from three months to 60 months with a minimum $1,000 deposit required.

While CDs help set aside your funds for a certain period, they do come with some caveats that are important to consider.

Pros

• Guaranteed rate of return - With CDs, you agree to deposit your funds for a set duration at a fixed interest rate, ensuring a consistent return on your investment.
• Higher yield than savings accounts- CDs typically offer a higher yield than savings accounts, including some high-yield savings accounts, since you have far less flexibility of when to withdraw your money.

Cons

• No liquidity- You won't be able to access your CD's money before the end of the term without penalty.
• Early withdrawal penalty- Penalty fees associated with CDs can vary depending on your bank and your CD's term length, but they're usually based on the interest earned or the interest you would have earned over a certain number of days or months.

An IRA is a tax-advantaged investment account that individuals with taxable income can set up through a financial institution.IRAs are like 401(k) plans in that you can invest money into different assets such as stocks, bonds or mutual funds but unlike most 401(k)s, IRAs can be opened by an individual instead of an employer.

Traditional IRAs allow for pre-tax contributions, meaning you generally won't pay any taxes on your contributions until withdrawal in retirement. Roth IRAs involve contributing after-tax dollars, allowing you to make tax-free withdrawals later in life.

IRAs also come with annual contribution limits and you must typically wait until age 59 ½ to start making withdrawals without penalty, according to the IRS.In addition, you must meet certain income qualifications to contribute to a Roth IRA — if you earn too much money, you might not be able to fund one.

If you want to open an IRA, go through a reputable broker you can trust. Fidelity Investments and Vanguard both offer commission-free tradingon various securities, such as stock and ETF trades, and zeroor low-expense ratioindex funds, making it relatively affordable to invest. Both also offer robo-advisor options for beginner investors new to the stock market.

IRAs are designed to help you grow your retirement savings. You shouldn't make any early withdrawals unless absolutely necessary, since they usually come with hefty financial penalties.

Pros

• Tax-advantaged - With traditional IRAs your contributions are tax-deferred until after withdrawals, while Roth IRAs allow you to contribute after-tax dollars and pay no tax on the withdrawals.
• Flexible investment options - Depending on your financial institution, your IRAs could offer a variety of investment options, including commission-free stocks or exchange-traded funds.

Cons

• Low annual contribution limit - IRAs come with annual contribution limits that the IRS adjusts every year.
• Early withdrawal penalties - Different early withdrawal penalties apply according to the type of IRA. For example, traditional IRAs usually levy a 10% penalty for early withdrawals before age 59½.

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