Unlocking Potential: Comparing IRA vs. CD vs. Money Market Accounts

Key Points

• IRAs, CDs and money markets are types of savings accounts.
• An IRA can hold CD and money market accounts.
• Annual contribution limits bind IRAs, while CDs and money markets have unlimited deposit caps.

Key Points

• IRAs, CDs and money markets are types of savings accounts.
• An IRA can hold CD and money market accounts.
• Annual contribution limits bind IRAs, while CDs and money markets have unlimited deposit caps.

Rising interest rates have spurred investors into seeking risk-free returns while avoiding the volatility of the equity markets. Savings accounts are designed to help individuals save money and earn interest income. Savers have finally gotten a reprieve from over a decade of zero-interest-rate-policy (ZIRP), which pushed many into the equity markets seeking yield. 

While dividend stocks provide income, they also come with volatility and the risk of losing some of your principal, ironically raising the dividend yield. The higher interest rates present compelling options for investors seeking income or growth while being able to adjust for volatility. You can save using IRAs, CDs and money market accounts. We will review and compare each type. 

By the end of this article, you should have a better idea of what works for you — IRA vs CD vs money market account.

Basics of IRAs

An individual retirement account (IRA) is a personal savings account designed to help individuals save for retirement. IRAs are flexible in that they can hold many types of financial assets, from certificates of deposit (CDs), stocks, bonds, mutual funds, exchange-traded funds (ETFs), dividend ETFs and annuities.

There are potential tax benefits in the form of tax-deferred or tax-free growth, depending on the type of IRA. With some exceptions, you can cash out IRAs after the age of 59 1½2 or else incur a 10% penalty. 

Learn to invest in an IRA early to use compounding, especially since the annual contributions limit. Be aware of the required minimum distribution (RMD) that requires a yearly minimum payment out of the IRA after age 73. IRA accounts are FDIC insured up to $250,000. However, assets like stocks, bonds, mutual funds and ETFs are not covered.  

Types of IRAs

There are two popular basic types of IRAs: traditional and Roth IRAs. While they are similar, they share some distinct differences that you should be aware of. Remember that you can have unlimited IRAs, but the annual contribution limits of $6,500 and $7,500 (if aged 50 or older) apply cumulatively between your IRA accounts. 

Traditional IRA

You can make contributions with pre-tax money, and proceeds are taxed as ordinary income when withdrawing during retirement. IRAs take more effort to manage from researching, selecting, acquiring, tracking and evaluating your investments. 

Traditional IRA contributions are only fully tax-deductible if an employer-sponsored retirement plan doesn't cover you. They may be partially or not tax-deductible depending on your employer's retirement plan and your spouse's employer retirement plan if filing married. IRAs take more effort to manage from researching, selecting, acquiring, tracking and evaluating your investments.

Roth IRA

Remember that only some are eligible to have or contribute to a Roth IRA. Suppose your modified adjusted gross income (AGI) is $218,000 or higher (filing married jointly) or $153,000 or higher (filing single or married filing separately). In that case, you can't make contributions to a Roth IRA. 

You make contributions to Roth IRAs with after-tax money. The contributions are not tax-deductible since you already paid taxes on the money you put in. 

If you become completely and permanently disabled, you can make penalty-free withdrawals. You can also withdraw to pay for qualified education expenses, for a birth or adoption, for unreimbursed medical expenses or health insurance (if unemployed). You can also withdraw up to $10,000 towards a first-time home purchase. 

You can make contributions to your Roth IRA up until age 70 1½2. You can leave money in a Roth IRA for as long as you live, and there is no RMD. 

Basics of CDs

A certificate of deposit (CD) is a savings account that holds a fixed deposit amount for a fixed period in exchange for an agreed-upon interest rate from the issuing bank or credit union. CDs purchased through a federally insured bank are insured up to $250,000 through the FDIC. 

The $250,000 applies to all accounts in your name at the bank, not per account or CD. When you buy a CD, you should be aware of the amount, the interest rate, the penalty and the maturity date. You can only withdraw money on the maturity date. Otherwise, it will incur an early withdrawal penalty. The amount of the early withdrawal penalty varies by bank. The lack of a cap on the deposit amount for a CD account versus an IRA is a primary advantage for savers with more significant lump sums of cash that exceed annual IRA contribution limits. 

Types of CDs

There are many different CDs to select from. CDs are suitable as an interest-bearing instrument, unlike a dividend stock, without the risk of losing any part of the principle. CDs are most suitable for savers and investors who don't need to access a lump sum of cash and want to collect a higher interest rate than a savings account. Be sure to read the fine print.

• Standard CD: This is the traditional basic CD where you make a fixed deposit for a specific period to collect a fixed interest rate. CDs tend to have a minimum deposit amount. There is an early withdrawal penalty if you withdraw your money before maturity. 
• Jumbo CD: This is a standard CD with a much larger minimum deposit ranging from $50,000 to $100,000 and tends to provide a higher interest rate than the standard CD.
• High-yield CD: This CD pays a higher interest rate but comes with a more extended maturity date, meaning you have to keep your money locked up longer than a standard CD.
• No-penalty CD: As the name says, this CD lets you withdraw early penalty-free. It behaves like a savings account, but they pay a slightly lower interest rate. You usually have to close out the total amount when withdrawing money, as they usually don't allow partial withdrawals. This one is also called a liquid CD. 
• Bump-up CD: This CD allows you to raise the interest once or twice on your CD if your banking raised its interest rates before the maturity date. These CDs are instrumental during monetary tightening periods when the Federal Reserve raises interest rates to slow down the economy and combat inflation.
• Step-up CD: This CD automatically raises the interest rate at specific intervals. The rate increase is predefined and automatically administered. 
• IRA CD: This is a standard CD held in your IRA account. Rather than being assessed taxes on the interest, it is deferred until retirement for a traditional IRA account. 

Basics of Money Market Accounts

A money market account is an interest-bearing savings account that offers a higher interest rate but requires a higher balance and limits the number of transactions. They are offered through banks and credit unions. 

Money market accounts allow a limited number of monthly transfers, check writing and debit card transactions. Benefits and restrictions can vary from bank to bank. Money market accounts are FDIC insured up to $250,000. 

Since it's a savings account, the bank assumes you will make deposits to grow the account and limit transactions that deplete the balance. 

Types of Money Market Accounts 

Money market accounts differ based on the features and terms they come with. If you violate the terms, money market accounts can also incur fees and associated penalties. This can also vary by bank or credit union. Here are some of the differences between money market accounts to watch for.

• Minimum balance: Money market accounts tend to have higher minimum balances than regular savings and checking accounts. Different banks will have different minimum balance thresholds that need to be maintained.
• Interest rates: This is a significant factor. Money market accounts generally correlate to short-term interest rates. Generally, higher minimum balances receive higher interest rates. Be sure to pay attention to whether the money market account has a flat or tiered interest rate.
• Accessibility: Money market accounts limit the number of monthly transactions, including withdrawals, check transactions and transfers. Some banks may charge a fee for making too many transactions or even convert the account to a checking account. Some banks may allow unlimited ATM transactions that don't count toward the monthly transaction limit. Due to the lower overhead, online banks offer higher interest rates than brick-and-mortar banks. However, they don't have physical locations to visit if there are any problems. 

Key Differences

These are the key differences between the various accounts. The basic rule of thumb is that more benefits tend to be proportionate to more restrictions. For example, higher interest rates tend to limit your funds' access for longer periods. 

IRAs vs. CDs

What’s the difference between an IRA and CD? 

An IRA vs. CD is like comparing fruit baskets to oranges. An IRA is a long-term retirement savings account, whereas a CD is a short-term interest-bearing time deposit account. An IRA comprises a portfolio of financial assets, including stocks, bonds, annuities and CDs. There is no reason to decide between a CD account vs IRA. You can do both. 

You can buy a CD in your IRA account, which is called an IRA CD. It operates like a standard CD. The interest you accrue on the CD is tax-deferred until withdrawal. However, you can only withdraw the proceeds once you are 59 1/2 years or older or meet various qualifying requirements. CDs held in Roth IRAs are tax-free upon withdrawal since no tax deduction is taken when purchased. One of the most significant distinctions is accessibility. Your funds are more accessible with a CD than an IRA if you aren't at least 59 1½2 years old. IRAs can take more time and effort to evaluate stocks and performance to manage, whereas CDs are simple transactions.

One of the most significant differences between an IRA and a CD is the unlimited maximum you can put into a CD compared to the $6,500 or $7,500 (if you're 50 years or older) annual contribution limit for an IRA. If you have an amount that exceeds the annual contribution limit as a risk-free investment, then you could use some or all of that excess money to buy a CD, assuming you won't need to access the money anytime soon. 

If you're asking yourself, "What's better, IRA or CD?", it depends if you are comfortable accessing your money once you're 59 1/2 years or older. 

CDs vs. Money Market Accounts

Both of these accounts are a form of interest-bearing savings accounts. CDs tend to offer higher interest rates because they lock up your deposit for the agreed-upon period. You can't make transactions or withdraw any funds from your CD until its maturity date, at which point you can pull all or part of the money or roll it over for another term. 

Money market accounts pay less interest than CDs but allow for a limited number of monthly financial transactions in the account. Money market accounts tend to have tiered interest rates that rise as the balance grows. Money market accounts have minimum balances. Both money markets and CDs can have maintenance and penalty fees that differ by bank or credit union. 

IRAs vs. Money Market Accounts

IRA accounts can also hold money market accounts, called retirement money markets. The accessibility is the most apparent benefit of a money market vs. IRA debate. IRA proceeds are only accessible after 59 1/2 years of age with qualifying withdrawals, whereas you can access money market funds anytime. No financial transactions are allowed in an IRA account before 59 1/2, whereas money market accounts allow a limited number of monthly transactions.  

Tax Implications of Each

There are tax implications to consider with each type of savings account that you may want to consider before you open one. 

IRAs

Traditional IRAs are tax-deferred until withdrawals are made in retirement or after 59 1/2. Qualified withdrawals are subject to ordinary income tax. Contributions are tax deductible unless you or your spouse has an employer-sponsored retirement plan. In that case, tax deductibility may be limited.

Qualified withdrawals are free of taxes. That means no income tax or capital gains tax is applied when you withdraw funds. Roth IRAs are not tax deductible since they are paid with after-tax proceeds. Learn more about niche IRAs, like gold IRAs.

CDs

The interest on CDs is taxed as ordinary income. Standard CDs are not tax deductible. Retirement CDs purchased in an IRA account are tax deductible and tax-deferred. 

Money Market Accounts

Like CDs, the interest earned on money market accounts is taxed as ordinary income. Money market accounts in a Traditional IRA are tax deductible and tax-deferred. 

Pros and Cons of IRAs, CDs and Money Market Accounts 

There are benefits and disadvantages to each type of savings account. Here's a breakdown of the instruments.  

IRAs

IRAs are tax-advantaged retirement savings accounts. Traditional IRAs are generally tax deductible and tax-deferred. Qualified withdrawals are capital gains and income tax-free for Roth IRAs.

However, you can only withdraw IRAs at age 59 1/2 or under specific conditions. IRAs have an annual contribution limit of $6,500 and $7,500 for those age 50 and older. Unqualified withdrawals can incur a 10% penalty and income taxes (for traditional IRAs). 

CDs 

CDs provide higher interest rates than most other deposit accounts, but the downside is that CD funds are locked up until maturity and can incur penalties for early withdrawals.

Money Market Accounts

Money market accounts provide higher interest rates and instant access to your funds, enabling you to make a limited number of monthly transactions.

However, fees and penalties can apply if money market account balances fall under the minimum balance or transactions exceed the monthly limit.  

Consider Your Options

Weigh all the pros and cons of each option and read your paperwork.

This sounds like basic advice, but read what you're signing online or in a branch. The fine print details include fees, penalties and cancellations. As they say, the devil is in the details. 

Be sure to familiarize yourself with the fees and penalty triggers that can eat into your gains. Benefits and restrictions can differ between different financial institutions, not to mention promotions. 

Promotions try to entice you to open an account, but things revert to the "regular" settings after the promotional period. Just be sure you understand the "regular" settings before you go the CD vs IRA or money market vs IRA route.  

FAQs

Here are answers to some of your frequently asked questions.

Is an IRA better than a money market account?

An IRA account can be better than a money market account if you are planning long-term toward retirement and seek to add different asset classes. Remember that IRAs have a limited annual contribution limit, which can significantly impede more significant gains from a larger investment. An IRA is a retirement account that can include money market accounts in its portfolio of assets. 

As a retirement account, the proceeds can only be withdrawn once you are 59 1/2 years old. A regular money market account provides immediate access to funds enabling depositors to withdraw funds up to the monthly limit for transactions. Money market accounts don't have a maximum limit. They pay more interest for higher balances. Note that similar to a CD or IRA combo, you can have both an IRA and money market account. It doesn’t have to be an either/or situation.

Which is better, CDs or money market accounts?

CDs are better if you seek higher interest rates and only need access to your cash on the maturity date. Money market accounts are better if you want the flexibility to access your money without penalties while earning interest. 

Why would you choose a CD over a money market account? 

CDs pay more than money market accounts because your money is locked in for the time duration until maturity. The primary reason would be receiving a higher interest rate for the same deposit money. CDs also provide an incentive to save but limit access to your funds with the risk of paying a penalty.