Where to Stash Your IRA Cash

Last Updated Jun 21, 2011 9:31 AM EDT

The Ally Bank 5 Year CD has been my cash-stashing recommendation for quite awhile but hasn't been available for IRA accounts - until this week, that is. As of Saturday, June 18, Ally has rolled out CDs for both traditional and Roth IRAs. This offers consumers the ability to earn intermediate-term interest rates with the same easy 60-day early withdrawal penalty, offering protection from a potential bond bubble. I'm very excited about this news, and here's why.

Great rate - No bond bubble worries
As of today, the Ally Bank 5-year CD is paying 2.37 percent APY. This compares to my favorite bond fund, the Vanguard Total Bond Fund (BND), yielding 2.66 percent APY. While Ally yields 0.29 percentage points less, it has less default risk and far less interest rate risk than the Vanguard bond fund.

While roughly 70 percent of the Vanguard bond fund is back by the US Government and government agencies, 100 percent of the Ally CD is backed by the FDIC, up to the $250,000 limit. This is additional insurance above your taxable money at the same institution.

And while I like the fact that the CD has less default risk, I love the fact it has far less interest rate risk. The experts have been predicting rising rates for some time and may even eventually be right. If this happens, we would expect the Vanguard bond fund to drop by about 5.2 percent for every one percent that interest rates rise, meaning a two percentage point rise in rates would hit this fund by over 10 percent, though you would earn 2.66 percent interest.

By contrast, you could simply cash in your CD and pay the 60 day early withdrawal penalty at Ally, amounting to a bit under 0.40 percent. You would then reinvest at a much higher rate rather than earn sub market rates for the remaining five year term. Here's more on this strategy of stashing your cash that I wrote earlier. Think of it as a one year CD paying 1.97 percent, after the penalty, if cashed in after one year. Following is my estimate of your earnings depending upon when you cash it in.

Great Rate - Perfect tax-location
Where we locate assets is critical for tax-efficiency and CDs, taxed as ordinary income, are best located in tax-deferred accounts. The stock indexed funds are best kept in your taxable accounts since they are so tax efficient already.

My advice
Ally's new IRA CD is big news. I wish to thank Mint.com writer Matthew Amster-Burton for bringing this to my attention, since I was floating on a cruise ship last Saturday when the roll-out happened.

This CD, as well as the Security Service Federal Credit Union 7-Year CD, are going to the top of my recommendation list. Both are now available in IRA forms. Though it bears mentioning that, in the case of Security Service, not all will qualify for one of the 2,000 ways to get membership at the credit union.

I love these CDs. And one of the reasons I love them is that they give small investors the ability to earn higher returns with less risk. While this is promised regularly by radio gurus and the like, it's very rare to find a legitimate opportunity that actually delivers. Now, you can have all of this with tax-efficiency to boot.

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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