Earning interest on your savings can be a smart way to grow your money – but you should be aware that it counts as income, and you may need to pay taxes on it. Keeping this in mind can help you make informed decisions and effectively manage your finances. If you earn interest on your savings account – even just $1 – you will need to report it on your taxes.
Luckily, there are several types of savings accounts and savings strategies that can help you reduce the amount of tax you’ll need to pay. Let’s look at how savings account interest is taxed and explore ways to minimize the impact.
Savings Options with First Merchants
Understanding tax on your savings account
When you earn interest on a savings account, checking account, or certificate of deposit, this income is considered taxable by the Internal Revenue Service (IRS).
No matter how much interest you earned, you’ll need to report the full amount on your tax return and pay any taxes on it. If you earned at least $10 in interest during the previous tax season, your bank will send you a Form 1099-INT– typically by January 31 of each year. If you don’t receive this form, you are still responsible for reporting savings account interest on taxes.
You should review your year-end account statements or contact your local attentive banker to help prepare for tax season. If you’re still unsure about what you owe, you can reach out to the IRS for assistance.
How much tax is there on savings account interest?
The tax rate on your savings account interest depends on your federal income tax bracket.
For 2024, you may pay between 10 to 37 percent tax on interest earned. For example, if you are in the 22 percent tax bracket and earn $100 in interest, you would owe $22 in federal taxes. You may also need to pay state taxes.
Types of savings accounts and their tax implications
Some savings account types are taxed differently, or vary in their tax requirements – from traditional savings accounts and high-yield savings accounts to certificates of deposit (CDs).
Regular savings accounts
Regular savings accounts are the most common type of savings account and are used by many people for general, short-term savings or to fund emergencies. While these accounts are simple to open and do offer interest, the rates are usually low.
Interest earned on regular savings accounts counts as income and is fully taxed. Banks will report if you earn more than $10 in interest each year, and will send you a Form 1099-INT.
You must also report interest from your regular savings account on your tax return, regardless of the amount. When filing an annual return, you’ll pay tax according to your income tax rate.
A regular savings account offers no special tax advantages.
High-yield savings accounts
High-yield savings accounts offer significantly higher interest rates than regular savings accounts. While the interest rates vary according to markets and the economy, they’re almost always higher than a regular savings account.
You also pay taxes on high-yield savings account interest. Like interest from regular savings accounts, it is considered taxable income and must be reported on your federal tax return.
The key difference with tax on a high yield savings account is that, due to higher interest rates, you are likely to earn more interest, potentially increasing the taxes you’ll need to pay versus what you’d pay on a regular savings account.
Money Market Accounts
A money market account (MMA) is a savings account that usually offers higher interest rates than a regular savings account. Money markets are unique because they may come with a debit card or the ability to write checks – something typically associated with a checking account. These hybrid accounts are perfect for those seeking higher interest rates, but who want some flexibility with their funds.
As with a regular savings account, interest earned from a money market counts as income and must be reported on taxes. The higher interest rates on a money market account means that you may end up earning more, and so paying more in taxes.
Certificates of Deposit (CDs)
Certificates of Deposit (CDs) are savings accounts that offer higher interest rates in exchange for leaving your money untouched for a specific period of time – ranging from a few months to several years.
Interest earned on CDs counts as income each year and is taxable – even if you don’t withdraw the money. Your bank will send you a 1099-INT form listing the interest earned, and you will use this form to file your taxes.
For multi-year CDs, you may need to pay taxes on interest earned each year, even though you cannot access the funds until the term is up. This is something to consider when choosing a CD account as it can affect your budget if you need to pay taxes on money you haven’t yet received.
There are also special rules if a CD is opened by a child, a parent opens a CD for a child, or a parent contributes to a child’s CD. If any of these apply to you, you should reach out to a tax professional for specific advice.
Individual Retirement Accounts (IRAs)
Individual Retirement Accounts (IRAs) are savings accounts designed for retirement and have special tax rules that apply to them. There are two types of IRA – traditional and Roth.
A traditional IRA is tax-deferred, meaning funds aren’t taxed until you withdraw them at retirement.. At that point, withdrawals are taxed as ordinary income. With a Roth IRA, however, you pay taxes on each contribution before it is deposited in the account – but you will pay no tax when you withdraw funds after retirement.
Health Savings Accounts (HSAs)
A health savings account (HSA) is an account designed for individuals enrolled in high-deductible health plans. It allows participants to save money for medical bills, prescriptions, and specific health-related purchases.
HSAs offer three separate tax advantages – contributions are tax free, growth is not taxed, and withdrawals are tax free.
While HSA funds roll over from year to year, there are annual contribution limits set by the IRS.
What is withholding tax on savings account?
Withholding tax is when a payer – like an employer -- subtracts a certain amount of tax from a payment before it is given to a payee such as an employee. Typically, savings account interest isn’t automatically withheld.
However, banks may withhold some of your savings account interest if they are instructed to do so by the IRS due to paying back taxes, or if you give your bank an invalid Taxpayer Identification Number (TIN). You can also request that your bank withhold part of your interest earnings.
To avoid automatic tax withholding on your savings account, make sure your bank has your correct TIN – this should match your IRS records. If you are subject to backup withholding, you may need to submit paperwork to resolve it.
Calculate tax on savings account interest today
When paying tax on your savings account interest, consider your tax bracket, state taxes, and alternative savings accounts to secure your money.
To effectively plan your savings and better understand potential tax implications, use our Savings Account Calculator. It helps you determine optimal savings goals, calculate interest earnings, and estimate your emergency fund needs, allowing for better financial planning and tax preparation.
This blog does not qualify as specific tax advice. Direct specific questions about taxes to your local tax professional.
