Fixed Rate Individual Retirement Accounts (also called CD IRAs) are certificates of deposit held within a traditional Individual Retirement Account (IRA) or a Roth IRA. As a result, any interest on the certificate of deposit accumulates according to the tax advantages of the IRA. In a traditional IRA, pre-tax income is deposited into the account where it accumulates until retirement age. At that point, when the money is withdrawn, the user is taxed at their prevailing tax rate.
In a Roth IRA, the user invests post-tax money and the funds are allowed to grow and be withdrawn at some future date tax free.
Fixed Rate investments can reside in either a Traditional or Roth IRA.
How to Open a Fixed Rate IRA
Many banks offer Fixed Rate IRAs. The bank can help the individual open the IRA. It is not a difficult process and is similar to opening a bank account. Once the FIRA's term ends, the money can be rolled over into a new FIRA (just like a CD), moved into another investment like stocks, bonds, mutual funds, etc., or withdrawn. If the money is withdrawn before the age of 59 and 1/2, then the IRS levies a 10% penalty charge on the amount withdrawn, on top of any taxes owed. There are two caveats to this penalty: paying for education, and buying a home.
Paying for Education
FIRA money can be withdrawn penalty free if the funds are used for education expenses from a qualifying institution. The funds can be used for the holder, a spouse, kids, or grandchildren. The institution must be approved by the IRS. Qualifying institutions include private, public, and vocations schools and expenses include tuition, books, and room and board.
Buying a First House
The IRS also allows FIRA money to be withdrawn penalty free if the funds are used to purchase a first house. An individual can pull out $20,000 towards a first time home. If a husband and wife purchase a home together, then the total could be as high as $40,000. And the funds can also be used to help children buy a home so a family with a father, mother, son, and daughter-in-law could potentially pull out $80,000 combined tax free from their individual accounts.
The IRS is also a bit flexible with the term first time homebuyer. As long as the buyer doesn't currently own a house, and hasn't owned one in the prior two years, they are considered first time homebuyers.
Roth IRAs treat homebuying slightly differently. After fiver years, you can withdraw the money tax free as a qualified distribution.
Advantages to a FIRA
There are several advantages to a FIRA:
- Money grows in a tax-advantaged way.
- Funds are FDIC insured, just like a regular CD.
- Interest rates on FIRAs are often higher than the same terms for a CD.
- Some flexibility in withdrawing the money early for first time homebuyers and education expenses.
Disadvantages to a FIRA
- Returns may not be as high as stocks, bonds, mutual funds.
- Funds cannot be withdrawn until 59 1/2 without penalty (except for IRS approved expenses).
- If interest rates rise during the term of the FIRA, money will be stuck in lower yielding account.
FIRAs are a great addition to any portfolio. They provide a tax-advantaged way to conservatively grow savings and prepare for retirement, college, or buying a home.