IRA CD Tax Rules

An IRA CD is a great tax tool to save money for retirement.tax forms image by Chad McDermott from Fotolia.com

An individual retirement account, or IRA, is a retirement savings tool that has tax advantages. The contributions made to an IRA account may be fully or partially deductible, while earnings and gains from your IRA are not taxed until distributed. Certificates of deposit (CD) are low-risk investments. A CD is a deposit account with a bank that has a higher interest rate than a normal savings account.

Account Setup

By combining IRA and CD benefits, you can enjoy both tax breaks and higher returns. However, you need to follow some tax rules to be able to use an IRA CD account. To set up an IRA account, you must be younger than 70 1/2 years old by the end of the year, and you must have received taxable income during the year. While CD's can be offered by brokerage firms, to have an IRA CD you have to set up your account with a bank or a federally insured credit union.

To make your contributions deductible, you need to follow some rules. People under 50 years of age are generally limited to $5,000 of annual untaxed contributions, while people 50 and over are limited to $6,000. If you make less than the limit, you cannot contribute more than your total income. If you have more than one IRA, the limit applies to the total contributions you make to all of your IRA's for that year. Your deductions on contributions may decrease or be eliminated if you or your spouse were covered by a retirement plan at work, depending on your filing status and income. These contributions must be made during the tax year in order to be included on the prior year's return.

You can withdraw funds from your IRA CD at any time, but if you are younger than 59 1/2 a 10 percent additional tax penalty will apply. There is one exception to this rule, however. Once you have made contributions into your IRA, you can still withdraw those contributions without penalty as long as you do so before the due date of filing the tax return for the year in which you made the contributions. Once your filing deadline has passed, though, the contributions for that year are locked into the system, and the normal penalties apply.

You will start to receive your distributions by April 1 of the year after you reached 70 1/2 years old. This date is called the "required beginning date." The minimum distribution amount can be calculated by dividing your IRA CD account balance by your life expectancy. There is a table provided for these calculations in Internal Revenue Service (IRS) Publication 590. You can find more detailed information in this publication, and since these rules are constantly changing, it is a good idea to always verify information on the IRS website for IRAs.