What Happens If I Cash Out an IRA CD Early?

An Individual Retirement Arrangement, or IRA, is a tax shelter. These accounts defer taxes on your investment earnings until you retire. When you do retire, taxes may or may not be due, depending on the type of IRA you invested in. Many IRAs held with banks use bank certificates of deposit, or CDs, as the primary investment in the IRA which need to be held for a certain time before they can be cashed out.

Process

• When cashing out an IRA early, you must notify the bank. The bank will liquidate your CD and ask what you'd like to do with the funds. You may purchase another CD, you may keep the money in an interest-bearing account, or you may withdraw the funds from your IRA.

Significance

• Bank CDs have maturity dates because they represent time deposits. You give your money to a bank, which invests it for a set period that you agree to. When the period is up, the bank returns the money to you. By cashing in your CD early, you are breaking the contract you agreed to with the bank.

Effects

• The effect of cashing out an IRA CD early is that you normally lose three months worth of interest. This may represent a significant portion of the earnings you've accumulated in the CD. Even though you lose interest on your CD, you don't lose any of the principal amount. Also, because the CD is inside an IRA, you are not taxed on any of the earnings of the CD.

Prevention/Solution

• To avoid the penalty of lost interest, keep the CD until it matures. This will ensure that you get all the interest you are entitled to under the terms of the CD.

Considerations

• Before entering into a contract with a bank to purchase a bank CD, consider what you want a bank CD for. Bank CDs are somewhat illiquid investments and may be long or short-term. When you purchase a bank CD, you must be relatively certain that you will keep the CD for the term of the deposit. If you don't think you can make such a commitment, consider an interest-bearing account or a money market fund which can be liquidated at any time with no penalties.