CD vs. IRA Accounts: Which Savings Option Is Right for You?

Saving money is an important step toward your financial goals. Maybe you've decided to start saving. But where? Financial advisors don't usually recomment piggy banks. And tucking cash under your mattress isn’t the way to go either.

Luckily, you have better options. Two popular choices are certificates of deposit (CDs) and individual retirement accounts (IRAs). Compare the features, benefits, and limitations of CD vs. IRA accounts to decide which is right for you.

Understanding the Basics: What Are CDs and IRAs?

A certificate of deposit, also known as a CD, is a type of savings account that pays interest when you deposit money and agree not to withdraw it for a set period of time. At the end of that period — the CD term — you get your initial deposit back with interest.

Basically, the bank or credit union offering the certificates of deposit is paying you to loan them some money for a time. In exchange, you earn interest on your deposit. The amount of interest you can earn on a CD depends on the term and the interest rates available.

If you withdraw your money before the end of the CD term, you will have to pay a penalty. That’s the downside. When comparing CD options, consider the term lengths, interest rates, and withdrawal penalties.

Individual retirement accounts, or IRAs, are savings accounts for retirement with tax advantages. There are two main types of IRAs: traditional and Roth.

With a traditional IRA, you deposit pre-tax money into your account. Those funds can reduce your total taxable income for the year, lowering your tax bill. A traditional IRA is a tax-deferred account, meaning you don’t owe any tax on your traditional IRA contributions now. Instead, you’ll pay tax when you withdraw your savings in retirement.

With a Roth IRA, you deposit after-tax money into your account. But once you’ve paid the tax, the retirement savings in your Roth IRA can grow tax-free. You won’t owe any taxes on qualified distributions from your account in retirement.

Key Differences Between CDs and IRAs

While both CDs and individual retirement accounts can be great saving options, there are some significant differences between them.

Time commitment

One of the major differences between IRA and CD accounts is how long they will keep your savings.

A CD is generally for shorter-term savings. The term lengths range from three months to 10 years, but 12-month CDs are especially popular. With those short term lengths, you’ll be able to access your savings plus interest in the relatively near future.

Because IRAs are retirement accounts, they typically require a longer time commitment before you can access your savings. Withdrawing your IRA contributions before you’re 59.5 years old can lead to an extra 10% tax for early withdrawals.

If you expect to need your money again relatively soon, a CD is probably the better choice for maximizing your savings.

Risk levels

CDs are relatively low risk. If your CD is through a bank, your money is insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). If your CD is through a credit union, your money is also insured up to $250,000 by the National Credit Union Administration (NCUA). This means there’s very little chance you will lose money with a CD.

With IRAs, your risk level can be higher. While an IRA can be invested in CDs, typically you invest these funds into assets such as mutual funds, stocks, or bonds. These assets can go up in value faster than CDs, earning you money. But they can also decrease in value, leaving you with financial losses. IRA savings you invest are market-dependent investments, so you have to accept the risk of market dips.

CDs: Advantages and Drawbacks

CDs are ideal for people looking for short-term savings with guaranteed returns. Because these accounts typically have fixed interest rates and terms, you know exactly how much you’ll earn when you deposit your money. Plus, the deposits are guaranteed up to $250,000 by either the FDIC or the NCUA, so your money is safe.

On the downside, even top CDs don’t offer very high interest rates. You can't touch your money for the length of the CD — otherwise, you’ll face early withdrawal penalties that eat into your savings.

A CD’s rigid terms might not suit someone who needs more flexibility. Minimum balance savings accounts may be the better option. Browse banking account reviews to find the best account for your needs.

Benefits and Limitations of Choosing an IRA

IRAs generally provide better long-term growth and contribution flexibility than CDs. You can start saving in an IRA as soon as you have taxable income and grow that money for years or even decades until your retirement. Both Roth and traditional IRAs offer tax benefits that make them extra appealing for your retirement savings.

A notable drawback is that IRAs are subject to a contribution limit. For 2024, you could only contribute $7,000 across all your IRAs or $8,000 if you’re 50 or older.

Some people may also find the complex rules governing IRAs confusing. Though you can withdraw your money at any time, there are potential penalties for early withdrawals.

Liquidity and Accessibility: Which Option Gives You More Flexibility?

When deciding between a traditional or Roth IRA vs. a CD account, one thing to consider is how accessible your money will be. If your financial situation changes and you need to dip into your savings, which would be better: a CD or an IRA?

Both CDs and IRAs have penalties for early withdrawals. With a CD, early withdrawal is anytime before the maturity date — the day when the CD term is up and you get your money back with interest. With an IRA, early withdrawal is before you turn 59.5 years old.

Your age and the CD term length you select will determine whether you can access funds from a CD or an IRA sooner. Generally, though, CDs are considered more liquid and accessible than IRAs because they have fairly short term lengths.

Tax Implications: How CDs and IRAs Affect Your Taxes

The money you deposit in a CD is after-tax, meaning you have already paid income tax on it. Opening a CD doesn’t help you lower your taxable income. In fact, a CD raises your taxable income because you owe taxes on the interest you earn.

With a traditional IRA, your contributions are pre-tax, which can reduce your current tax burden by bringing down your taxable income. However, when you retire, you will owe taxes on your withdrawals.

Roth IRAs work the other way around. You pay income tax on the money you contribute to your Roth IRA now, but you don’t owe anything for qualified withdrawals in retirement.

Keep in mind that with both Roth and traditional IRAs, you’re subject to a 10% early withdrawal penalty if you take money out of your account before you turn 59.5 years old.

Making the Right Choice: Which Option Is Best for You?

Selecting the right account for your savings will help you grow your money and reach your financial goals. CDs and IRAs are both great choices — you just need to decide which is best for you. Explore CDs, IRAs, and other savings account options on MoneyAtlas to find the right fit.