I’m 70 years old and I sold my house in August 2022 for $250,000. I invested the proceeds — after paying off the mortgage balance, car, etc. — in IRA CDs.
If I cash out one of those IRA CDs for $11,000 plus interest after it matures in March, do I have to pay taxes on the principal or only on the interest?
Planning My Next Move
Dear Next Move,
Rising interest rates put a fresh allure on CDs, even more than the swelling nostalgia for cassette tapes.
Like the mix tapes that supplied my school-bus soundtrack, there are a lot of CD mixes out there.
You’re asking if the Internal Revenue Service is going to tax your interest or your principal at maturity. If you bought a traditional CD, the IRS would tax the interest generated from your CD. (Read more here on the tax twists for those types of CDs.)
For an IRA CD, there will be an income-tax hit on the full sum – the interest and the principal – if you pull it out for your own use instead of rolling over the money into a new IRA CD. It works the same as a distribution from a straightforward IRA.
An IRA CD “will operate tax-wise like any other IRA,” said Brian Kearns, founder of Haddam Road Advisors in Evanston, Ill.
Those same IRA rules are something that could trip you up, added Michelle Jann, director of wealth planning and senior wealth adviser at Goelzer Investment Management in Indianapolis, Ind.
I don’t know how much of the $11,000 you put in the IRA CD each year since 2022. But if it was all at once, you may have inadvertently stuffed in too much money because the yearly contribution limits that apply to IRAs also apply to IRA CDs, Jann said.
IRA CD versus CD
“It’s extremely confusing and in personal finance, we have so many acronyms and industry jargon,” Jann added. “A lot of times, especially with CDs, it gets mixed up. Is a CD in an IRA an IRA CD? It’s not uncommon for that to cause confusion.”
A traditional IRA is a tax-deferred retirement account that can buy stocks, bonds and other assets, including CDs.
An IRA CD is also a tax-deferred retirement account, but the money only goes into a CD that matures over time, Kearns said.
Whether it’s an IRA or an IRA CD, the same yearly contribution limits apply. This year, it’s $7,000 for people under age 50 and $8,000 above that age. (For 2022, the contribution limit was $6,000 under age 50 and $7,000 above that age.)
There’s no immediate tax hit on the interest generated by CDs as they sit inside an IRA — and the same goes for stocks or bonds growing in value inside that IRA. There’s also no immediate tax event on the interest that builds inside an IRA CD.
For both IRAs and IRA CDs, the taxes only kick in when withdrawals are made. “If it stays in there, in that wrapper, there is no taxable event,” Stearns said.
Withholding taxes
Now what? Be ready for the tax hit if you pull it for distribution. You can elect to have tax withheld from your IRA CD distribution, Jann said.
If the money was deposited all at once, be aware that the Internal Revenue Service could charge you over-contribution penalties.
The IRS says “excess contributions are taxed at 6% per year for each year the excess amounts remain in the IRA.” But there are ways to address this, the agency notes.
Find a certified public accountant or another tax professional to help you with those next steps, she said. It would also be good to reach out to the financial institution that got you into these IRA CDs, she added.
Now let’s think about the bigger picture. Supposing you have no issues with the IRS and you don’t need the full amount. You could take a partial distribution and roll the rest into a new IRA CD, Jann said. That keeps income taxes at bay for now.
Of course, you’re also not getting the money until another maturity date. If you need it before that point, you’ll face the CD’s early withdrawal penalty.
If you need the money, take, but be ready for the taxes that come with it, Stearns added.
If you’re pulling the money to put it towards other types of investments like stocks, fixed income, mutual funds, ETFs and the like, that’s a different matter. Stearns said you will need to think about your stomach for risk, your goals and the other pros and cons of those products.
Got a tax question? Write me at [email protected].
Thanks for reading. I want to help you think more broadly about the issues that affect your taxes. I’m not offering tax advice, just an attempt to look at what the swirl of tax rules and economic conditions could mean for your wallet.