Certificate of Deposit (CD) vs. IRA: What's the Difference?

Certificates of deposit (CDs) and individual retirement accounts (IRAs) are two of the most popular savings options. While both help individuals grow their money, they serve different purposes that offer unique advantages. If you’re deciding between CDs vs.IRAs, it’s important to understand how each works and what role they can play in your overall financial plan. A financial advisor could help you decide which one best fits your investment portfolio or long-term goals.

What Is a CD Account?

A certificate of deposit (CD) is a type of savings account offered by banks and credit unions that pays a fixed interest rate for a specific term, ranging from a few months to several years. When you open a CD account, you agree to leave your money in the account for the duration of the term, and in return, you receive a guaranteed interest rate.

CDs are considered low-risk because they are insured by the FDIC or NCUA up to $250,000 per depositor. At the end of the term, or maturity, you can withdraw your initial deposit along with the interest earned.

The primary benefit of a CD is the higher interest rate when compared with a regular savings account. However, there are penalties for withdrawing your money before the CD matures, so it’s important to choose a term that aligns with your financial goals and cash flow needs.

What Is an IRA?

An individual retirement account (IRA) is a tax-advantaged investment account designed to help individuals save for retirement with the added benefit of tax advantages.

There are two main types of IRAs: traditional and Roth. In a traditional IRA, contributions may be tax-deductible and you won’t pay taxes on the earnings until you withdraw the funds in retirement. In a Roth IRA, contributions are made with after-tax dollars, but qualified withdrawals in retirement are tax-free.

IRAs can hold a variety of investments, including stocks, bonds, mutual funds and even CDs. The flexibility to choose your investments allows for growth potential over the long term.

However, there are annual contribution limits and penalties for withdrawing funds before reaching age 59.5, with some exceptions. IRAs are ideal for individuals looking to grow their retirement savings

CDs vs. IRA Accounts

A financial advisor comparing the benefits of CDs and IRAs.

Before you invest in a CD or an IRA, consider your financial goals, liquidity needs, tax benefits and potential returns and risks. Here are five general comparisons to help you decide:

Purpose: A CD is a short-term investment with guaranteed returns. An IRA, on the other hand, is designed for long-term retirement savings, allowing for various investments that can grow over time. IRAs are meant to help build wealth for retirement, whereas CDs provide a safe place to store money for a few months or years.
Risk and returns: CDs are low-risk because the returns are fixed and guaranteed. IRAs, while potentially offering higher returns, invest in stocks, bonds and other market-based assets. The value of your IRA can fluctuate based on market performance.
Tax treatment: CDs are taxed like any other savings account, meaning the interest earned is subject to ordinary income tax in the year it’s received. IRAs, however, offer tax advantages. In a traditional IRA, contributions may be tax-deductible and taxes are deferred until you make withdrawals. Roth IRAs offer tax-free withdrawals in retirement, making them attractive for those who expect to be in a higher tax bracket.
Liquidity: CDs are less liquid than other accounts because withdrawing money before the term ends results in a penalty. IRAs have restrictions as well, with penalties for withdrawing before age 59.5, but some exceptions for IRA hardship withdrawals, like buying a first home or covering medical expenses, may allow early access without penalties.
Contribution limits: CDs don’t have contribution limits; you can deposit as much as you want. IRAs, on the other hand, have annual contribution limits set by the IRS, which in 2024 are $7,000 for individuals under 50 and $8,000 for those 50 and older.

Types of CDs and IRAs

Both CDs and IRAs come in different forms, each offering specific benefits based on your financial goals and circumstances. Exploring the various options can help you select the product that best fits your savings or retirement strategy.

Common CD Variations

CDs aren’t one-size-fits-all. Depending on your need for flexibility, access, and CD rates, different types of CDs may offer better advantages than a standard fixed-term account.

Jumbo CDs: Require a larger minimum deposit, often $100,000 or more, in exchange for a higher interest rate.
No-Penalty CDs: Allow you to withdraw funds before the maturity date without incurring an early withdrawal penalty. These are useful if you need more flexibility.
Bump-Up CDs: Let you take advantage of rising interest rates by giving you one or more opportunities to “bump up” your rate during the term.
Brokered CDs: Sold through brokerage firms, these may offer higher yields but can carry more risk, especially if sold on the secondary market before maturity.

Types of IRAs Beyond Traditional and Roth

IRAs also come in multiple varieties beyond the commonly known traditional and Roth accounts. These alternative IRAs are often geared toward self-employed individuals or small business owners, offering unique tax benefits and higher contribution limits.

SEP IRAs (Simplified Employee Pension): Designed for self-employed individuals and small business owners. These accounts allow for higher annual contributions than traditional or Roth IRAs.
SIMPLE IRAs (Savings Incentive Match Plan for Employees): Another option for small businesses, SIMPLE IRAs are easy to set up and allow both employer and employee contributions.
Rollover IRAs: Created by transferring funds from an old employer-sponsored retirement plan, like a 401(k), into an IRA to maintain tax advantages.

Each variation has its own rules and ideal use cases. A financial advisor can help you evaluate the pros and cons of these different account types and determine which ones align with your short- and long-term financial goals.

CDs vs. IRAs: Which Should You Choose?

Choosing between a CD and an IRA depends on your financial goals.

CDs are best for those seeking a safe, low-risk option to store money without concern about market fluctuations, especially if you’ll need access to the funds soon.

An IRA, on the other hand, is more suitable for long-term retirement planning. If your goal is to grow your wealth over time, an IRA offers tax benefits and potentially higher returns through market-based investments. A traditional IRA may help lower taxable income now, while a Roth IRA provides tax-free income in retirement.

Many investment portfolios use both. A CD offers security for short-term savings, while an IRA helps build long-term wealth. Together, these options can provide a balanced financial approach.

Bottom Line

A financial advisor meeting with clients to review a portfolio.

CD and IRA accounts both play important roles in your investment strategy. CDs provide a safe, predictable way to earn interest over a short term, while IRAs are designed to help grow retirement savings with the added benefit of tax advantages. Your choice could depend on whether you need short-term security with steady interest (CD) or long-term growth with tax benefits for retirement (IRA).

Investment Planning Tips

Whether you’re picking a CD or an IRA, or both, a financial advisor could help you determine which type of account or investment will fit your needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you want to know how much your investment could grow over time, SmartAsset’s investment calculator could help you get an estimate.