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Can You Have a Savings Account in a Roth IRA? Print
Wednesday, 7th November 2007 (by J.D.)This article is about Investing, Savings
Yesterday, Brent wrote with a question regarding the types of investments one can have in a Roth IRA:
Is there such a thing as a Roth IRA “savings” account that gets rates comparable to a good “regular” savings accounts (5% APR or higher)? Is there a reason this is so difficult to find information on (at least for me)? It seems like any place that I want to take my Roth IRA to will require me to invest in mutual funds. It is currently in a savings account at Wells Fargo making somewhere around 1%, which I know sucks. I’m just wondering why there are so many savings accounts advertised everywhere giving (relatively) good interest rates but none that I can find for a Roth IRA.
Many investments one can make outside an IRA can also be made inside an IRA. The trick is finding an institution that can help you make the investments you want. A savings account isn’t really appropriate for an IRA, however. Though it’s possible to withdraw money from your account under special circumstances, IRAs are designed for retirement, not for easy fund access. (For more discussion on this, please see the comments on this post.)
Still, there are options available that mimic the risk and return of a savings account. Two spring immediately to mind.
First, if your IRA is held through a brokerage, you may able to obtain a relatively high rate through the company’s money market fund. For example, my Roth IRA is currently with Sharebuilder. Most of that money is invested in stocks and index funds, but the cash that isn’t sits in a money-market fund. If I wanted, I could hold all of my retirement investments in this fund. That fund currently earns me 4.35%, though it is not FDIC-insured. (A quick glance at ING Direct’s site reveals a slightly higher rate.)
A second option is to put the money into certificates of deposit. You lose some flexibility when you tie your money up in CDs, but they offer decent returns over the short term. I phoned my credit union to ask about their current rates for CDs held inside a Roth IRA. As of today they offer:
- 12 months @ 4.40%
- 24 months @ 4.75%
- 36 months @ 4.95%
The offer longer CDs, too, but the rates top out at 4.95%. Your bank or brokerage may provide similar options. (Check Bankrate for more information.)
While it’s possible to make investments in your IRA that approximate the risk and return of a savings account, they should be viewed as “deposit only”. You want to put the money in, but not withdraw it until you’re ready to retire.
Thanks to Dylan of Swan Financial Planning for his help in preparing this response.
November 7th, 2007 at 12:25 pm
Watch out for low interest rate default sweep accounts in your retirement or regular brokerage accounts. You can earn a much better rate by moving the idle money into a higher interest money market fund. -R
November 7th, 2007 at 12:37 pm
Good advice, but a little misleading. The question from the reader was about a Roth IRA, from which you can withdraw your contribution (not gains or earnings on that money) at anytime for any reason without penalty or tax concerns. The response to the reader’s question seems more geared towards a traditional IRA.
In any event, I do agree with your “deposit only” philosophy for retirement assets.
November 7th, 2007 at 12:46 pm
Oops. Thanks, Steve. You’re absolutely right. That’s a mistake on my part. I’ll edit the post to correct it. Am I correct that once you’ve withdrawn some of your contribution, however, you cannot return that contribution? That is, if I take $1,000 out in 2008, if I return that $1,000, it’s going to count against my 2008 contributions, yes?
I’ll get the correct information incorporated into the post.
November 7th, 2007 at 1:00 pm
Brent, it is possible to find IRA savings accounts. My credit union offers one–here’s a link to its rates page–though you’ll see that it’s got a low interest rate comparable to a non-IRA savings account.
http://www.fuzeqna.com/wsecu/consumer/kbdetail.asp?kbid=1246
I’m guessing that the utility of an IRA savings account is that it’s a place to park money until you have enough to put your accumulated funds into something with a better return, but also a minimum balance. Further down on that page cited above there is a block of info on IRA certificates (CDs)–the minimum there is $500. I’m guessing money market or mutual funds would have even higher barriers to entry. So, an IRA savings acct would get someone on the way to meeting those minimums.
Unfortunately I don’t have any good recommendations about IRA savings accts with better yield, like the internet banks. But, I can vouch that these products exist!
November 7th, 2007 at 1:08 pm
J.D., from everything I understand you are correct. If you withdraw the $1,000, you cannot replace it ever unless there was a year you were otherwise not going to be able to max out your contribution.
November 7th, 2007 at 2:37 pm
Another thing to look at would be funds focusing on high-quality bonds. These funds are low risk and usually return something between 4% and 5% yearly, compounding monthly. I have one in my 401k, and it works by distributing out gains every month to share holders, who then buy shares for the next month at a dollar each. Rinse and repeat.
Obviously, if CDs are obtainable at similar rates, those would be a better choice, since once the money is in an IRA you probably don’t want to touch it anyway. So the normal time-lock disadvantage of CDs is not present. Actually, that makes me wonder why these companies offer them in the first place… They pretty much have your money locked already in an IRA. Why do they offer CDs to further lock in the money? Strange.
November 7th, 2007 at 3:51 pm
Justin, I think that financial institutions want the knowledge of how long your money will be there (i.e., how long they can use it–where do you think that interest comes from? Not from the kindness of their hearts!)
After money is committed to an IRA, it can be “rolled over” to other kinds of accounts or to other institutions. Just like an IRA savings acct might be a good place to park little bits of money until you’ve got enough to invest elsewhere, an IRA CD might be a good place to park money for a while til you’re able to figure out which higher-yielding investment you’d like to roll that money over to.
Or, for someone who needs to be really risk averse–someone who’s close to retirement, or at retirement age and needs to keep their capital intact, an IRA CD might be considered an ultra-safe choice that still has somewhat better yields than a savings acct.
November 7th, 2007 at 4:01 pm
I’ve enjoyed the ease of use of my savings account at E-trade. It gives me an apy of 4.7% with no fees or minumums.
I only recently began a Roth IRA at E-trade. It does require a bit of homework to pick a good fund(s).
November 7th, 2007 at 6:37 pm
While not mentioned, I sit here thinking about Brent’s age. Maybe it is just me but I can not understand why you would want to keep retirement funds in a savings account. Just like money markets, I consider a savings account to be a place to park funds for a short period or for an emergency. Even from a high yield account you are not going to get any significant growth from your funds (My current ING rate is 4.2APY). Figuring on inflation at 3%, you do not have much of a pad against inflation with typical high yield savings rates and you are under inflation with many bank IRA savings rates (my credit union’s IRA savings rate is 1% APY). To go back to my comment regarding Brent’s age, I am taking a guess that the reason for avoiding mutual fund or other investments is due to the fact that he is nearing retirement and scared of risk. If that is indeed the case, as mentioned by others, there are plenty of low cost funds out there that invest in bonds and other “safe” investments that will provide a much better return against inflation than a savings account.
November 7th, 2007 at 7:59 pm
James: Although not mentioned, one thing I see mentioned by many people beginning retirement savings is the minimum that is required for many mutual funds. It seems like there is a bit of a “market” for an IRA that will take your money in a money market in $100 to $200 increments until you’ve contributed the $2k to $3k for many mutual funds. Once you have the minimum, mutual funds make the most sense because they allow for continual investment, but until you reach the minimums people seem to struggle with what to do with the money (and keep it socked away without the potential to raid it).
Now that I’ve said that, I’m sure someone will point me to a place that allows for just what I’m talking about
November 7th, 2007 at 8:22 pm
I spoke with a woman in her mid-50’s the other day and she discussed where she has her Traditional IRA funds. To my shock and disgust, she told me she has ALL of her money wrapped into a CD, inside her IRA at a bank. At 50-something, that is OBSCENE. And assuming this comment was from someone under 50-something, it gets even more gross.
My jaw almost dropped, but not as far as this person actively seeking this low-level, “savings” type account. You can’t even blame some creepy salesman who led you down the wrong path.
Since you are always supposed to say something positive first, I will start by saying it is excellent that you are asking questions and actually are pursuing saving for your future, but that is where the good stuff ends.
Please, PLEASE max out your IRA each year and buy something outside of a money market savings fund. Buy an ETF after you have $500 saved. Transfer your IRA [if you have one opened] to a low-cost fund company that will allow you to get started buying $50 a month if that is all you can afford, but there is no worse thing to hear [other than not enrolling in a 401k for 17-years like I heard today] that someone wants to allow their hard earned savings sit there and collect dust after going 95% of the way by opening an account. The whole idea that you have to save “a lot” of money to get going in a mutual fund is a crock.
This kinda stuff frightens me to death. To actively seek a 2% return inside a tax-advantaged account makes me do a full body shake in horror.
Even just buying VTI or DIA or something to hold you over until you learn is 100-times better than allowing some teller at a bank to make a $5.00 sales commission for scamming…..errrrr….I mean opening up a IRA for you.
November 8th, 2007 at 3:58 am
JD, My husband and I each have Roth IRAs we’ve contributed to for about 6 years. Maxed them out. This summer because of a family medical crisis we wanted to help with, we withdrew some of it for the first time. Not the earnings/dividends, just a portion of our contributions. We had 60 days to replace the money. There were some rules to it such as the money had to be sent via check so as to avoid trying to read the market. They are with Vanguard. That’s just my experience….every investment firm may have its own rules about such things.
November 8th, 2007 at 4:18 am
Daria- I think that the major factor in what you are describing is a combination of the firm and the fund. There are indeed brokers and funds that will not do this to you, have $100 initial minimums, and have still had averages of over 12% return over the last 5-10 years.
November 8th, 2007 at 11:21 am
Since you mentioned CDs and someone else here mentioned ING Direct, they’ve got CDs at comparable rates to the ones you mention in your post. Best part: they don’t have minimum deposits. So somebody who is literally starting out with not much to save, like me, can nevertheless get a higher interest rate on their savings than they would from a savings account if they are having trouble, say, opening a money market account or something. And MMAs have minimum deposits anyway. Savings is a good habit for anybody to take up, not just middle-class or rich folks, and the easier it is and the greater the payout, the better.
Also, even though you face the same kinds of penalties through ING if you close your CD early, it’s remarkably easy to do.
November 8th, 2007 at 8:39 pm
This was Roth IRA discussion. Do folks understand the differences? I am confused here.
A CD for a young person inside their Roth IRA is foolish and flat out one of the most financially silly moves one could make.
November 9th, 2007 at 3:34 am
This is a great post from Dylan. I was also surprised to learn recently that you can invest in all types of things–not just traditional stocks and bonds, but also real estate, private stock, tax liens, mortgages with an IRA. The advantages being that you get greater diversification and can invest in things in which you are familiar/believe with the potential to grow your money tax-free if you use a Roth IRA. Of course, there are rules you need to follow. This company is one of a handful that helps investors to invest in alternative assets with an IRA: http://www.trustlynk.com There is a good article on this, as well, at: http://moneycentral.msn.com/content/Retirementandwills/InvestYourSavings/P149985.asp
Hilary
November 10th, 2007 at 4:26 am
[...] Get Rich Slowly: Answers a reader question - Can You Have a Savings Account in a Roth IRA? [...]
November 11th, 2007 at 8:40 pm
The simple answer is that you can invest whatever you want in a Roth IRA.
But you shouldn’t do this. A savings account/money market only pays 15% dividend taxes, not regular income tax or capital gains.
A money market will return around 5% at most per year. So on as much as $10,000 in a money market, the most you will make is $500 in gains, and pay .15 * 500 = $75 in tax. So you are declaring $75 as tax free.
That’s insane. Don’t do this.
November 12th, 2007 at 7:49 pm
I dont trust the government. especially with bush as president.
November 13th, 2007 at 8:05 am
[...] Can You Have a Savings Account in a Roth IRA? Now this is something right up my alley way. Who knows maybe down the line I can help to contribute a piece like this one. The advice given is spot on. Although, I think it would be nice to know the age of the person asking the question. Depending on what phase of life you’re in impacts the decisions you make in a Roth IRA. [...]
December 4th, 2007 at 2:48 am
A savings account inside a Roth IRA can be appropriate for some people. For example, if you are over 59 1/2 and retired and are drawing money out of the Roth, you may want to have some of your money in a savings account, and it makes sense to leave the money in the Roth as long as possible.
January 23rd, 2009 at 12:32 pm
Now that we’ve been through a bull-hell year (2008), I’m really curious see how much the readers’ comments have change…
January 30th, 2009 at 2:07 pm
I found this discussion through Google, and reading the comments was very interesting. Have to laugh at all the people who thought putting money into stocks was a fool-proof way to retire.
Maybe the market will come back. Maybe not. That warning about past results being no guarantee about future performance was all but ignored by most investors. Now they are probably regretting investing blindly.
We’ve been through an extraordinarily positive time for stock market investors over the last 60 years, even with the latest downturn. Maybe our luck is up.
February 9th, 2009 at 11:40 am
Savings Account IRAs (Roth or Traditional), like other IRA products, are good for some people under certain circumstances. Someone already mentioned the accumulation phase, waiting to build up the minimum initial investment needed for many mutual funds. Another great example would be cash that is parked, ready to move without penalty, just waiting for the right investment opportunities, but on which one wants a return and some sort of FDIC protection while waiting.
Before the (almost) unimaginable happened in 2008–legendary investment banks (Lehman, Merrill Lynch, Bear Stearns, etc.) gone bust, Reserve Money Market Funds breaking the buck, TARP, Bernie Madoff–the conventional wisdom was that only the financially illiterate would want to keep any IRA money in FDIC insured accounts at banks. Now that we’re entering The Great Depression II, it can be one of the many prudent choices for those of us who still have money left. A 2% APR yield on a portion of one’s IRA assets during market turmoil is much better than a -33% return on the IRA portfolio.