Banks and other financial institutions offer a wide range of saving and investment accounts, and the sheer number of options can make it difficult to choose the best place to put your money. Individual retirement accounts and certificates of deposit are common types of accounts that differ on a fundamental level. IRAs are retirement accounts that act as a container for underlying investments, while CDs are a high-interest savings product.
An IRA is a type of tax-advantaged retirement plan that you can open on your own with a financial institution like a bank, mutual fund company or stock brokerage firm. You can contribute up to $5,000 to an IRA each year if you are under age 50 and $6,000 if you are 50 or older. The money you contribute to an IRA goes into underlying assets like stocks, bonds or mutual fund or interest-bearing accounts like savings accounts.
How CDs Work
A certificate of deposit is a type of savings vehicle in which you save funds until a maturity date that is determined in advance and you earn a fixed interest rate on your money until the maturity date. For example, if you open a two-year CD that pays 5 percent interest, you commit to saving your money for two years while gaining an annual return of 5 percent. CDs typically offer higher interest rates than normal savings accounts, because your access to funds is usually restricted. If you withdraw money from a CD before the maturity date, you may forfeit interest or face other fees.
IRAs and CDs are completely different financial products. An IRA is a retirement account that can contain other investments, while a CD is essentially a specialized savings account. You can have a certificate of deposit within an IRA, and an IRA can be a good place to keep a CD. Because an IRA is designed as a way for you to save for retirement and you face tax penalties on early withdrawals from IRAs, you aren't likely to withdraw funds before your CD reaches maturity.
Interest income is considered ordinary income by the Internal Revenue Service and is taxable at your normal income tax rate. This means you have to report the interest you receive from a CD on your income tax return. Individual retirement accounts offer tax deferral, which means you don't pay taxes on investment gains within the account, such as interest, dividends or capital gains. By holding a CD inside an IRA, you can avoid paying taxes on the interest the CD generates.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.