How Do I Ladder My IRA CD Without Taxes or Penalties?

Finding the best CD rates for your IRA may involve changing banks. Here's how to change CD investments in your IRA rollover without triggering taxes and penalties.
By Richard Barrington

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Q: I have my IRA invested in a CD, but it isn't earning much. I'm thinking of switching to a CD ladder to try to get more out of it, but I'm concerned the switch could trigger taxes and penalties. How do I make this switch without it costing me money?

A: There are a few components to this, so it might be best to break your question down into three smaller questions:

Is a CD the right investment for your retirement plan?

CDs have the benefit of safety and predictability, which may be desirable if you are nearing retirement age and expect to be drawing from your CD in the near term. However, if you have several years until retirement or you otherwise don't need to make significant withdrawals from your IRA for the foreseeable future, growth instruments may be more appropriate investments.

The time frame of when you anticipate drawing from your IRA is significant for two reasons:

  1. A shorter time frame may dictate when investments need to provide liquidity.
  2. A longer time frame may make inflation more of a concern.

The shorter time frame would make investments like CDs more appropriate, while the longer time frame may suggest mixing in some growth investments like stocks.

What do you gain by laddering?

CD laddering can be a useful technique to manage cash flow or to hedge against changes in interest rates. However, if you have a few years before you have to worry about liquidity, you might be better off with the higher rates offered by long-term CDs.

The ideal situation is when you are still contributing annually to the IRA. If you buy a new long-term CD each year, that naturally creates a CD ladder which will eventually start to mature at regular intervals -- but you will still be benefiting from higher long-term CD rates.

Where are the best CD rates?

Speaking of CD rates, before you restructure your CD holdings at your current bank, take a look to see if that bank is offering fully competitive CD rates.

On the CD rates page, the best CD rates across a range of different maturities pay well over 1 percent more than the national averages. Rates are updated every week, so take a look at that page before you settle for what your bank is offering.

How to avoid taxes and penalties

As you point out, avoiding taxes and penalties is an important consideration when making changes to IRAs with CDs.

Take a look at your current CD and find out what the interest rate, maturity date, and early withdrawal penalty are. If it is scheduled to mature soon or if it pays a competitive rate, you may want to wait until it matures before making any changes. Otherwise, you may you have more to gain by paying the penalty and shifting to a CD with a better rate.

If you decide to switch to another bank, inform both institutions that you want this to be a trustee-to-trustee IRA transfer. This allows you to change IRA custodians efficiently and without triggering tax consequences. The rollover to a new IRA must be made within 60 days, otherwise the withdrawal might be subject to taxation. (You should also check if either bank charges fees associated with a trustee-to-trustee transfer.)

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