One of the best features of savings accounts is the ability to earn interest. Without doing any work, you get paid simply for keeping your money safely tucked away in an FDIC-insured account. But is savings account interest taxable?
In most cases, the answer is yes—savings accounts are taxable by default. Tax-deferred savings accounts are the exception, limited to a few specific account types like traditional individual retirement accounts (IRAs) and 401(k) plans.
As with any other income, you must report taxable interest on your annual income tax return. Here's a closer look at how taxes are applied to savings account interest, and the terms and forms you may need to know when filing your taxes.
Taxable Interest on Savings Accounts
In most cases, the interest you earn from a savings account is considered taxable income by the Internal Revenue Service (IRS). As with income from your job, investments or nearly anywhere else, keeping close records and reporting all income on your tax return is expected.
How to calculate interest on savings accounts
Interest is typically paid as a percentage of your savings account balance. For example, if you have a $100 balance and the account offers a 1% interest rate, measured as annual percentage yield (APY), you would earn $1 over a year. With a higher interest rate or balance, your earnings increase. With most savings accounts, interest rates can change at any time without notice.
Your taxes are based on a percentage of the interest earned. Check your final bank statement of the year or look for a tax notification from your bank for the final amount for tax purposes.
Use our handy calculator to see how much interest you can earn with a Synchrony Bank High Yield Savings Account.
How tax is calculated on savings accounts
To calculate taxes owed for a savings account, you'll need to know the total interest earned, as calculated above, and your expected annual taxable income. Using your total income, you can look up your tax bracket, which is set by the IRS. Your tax bracket corresponds to a percentage of your income, including interest income, paid in taxes.
For example, assume your top income tax rate is 25% based on your income, and that you earned $20 in interest income for the year. Your taxes would be 25% of the $20 earned ($20 x .25), or $5.
If you earn $10 or more in interest in a year, you'll automatically receive a 1099-INT tax form from your bank with a summary of your earnings. The IRS also receives a copy. The tax rate you pay varies based on your income and other factors. Check with a trusted tax professional or preferred tax software to determine your income tax rate.
Tax-Deferred Interest on Savings Accounts
While you may earn interest regularly from a tax-deferred savings account, you only have to pay taxes on it once you cash out or close the account. This is known as tax-deferred interest.
Accounts with tax-deferred interest
In most cases, tax-deferred interest is limited to tax-advantaged accounts related to retirement, healthcare or education. For example, a traditional individual retirement account enables you to earn interest and defer all interest until you withdraw in retirement, when you're likely to have a lower income tax rate than during your working years.
However, if you withdraw early or outside of approved parameters, you could owe taxes and penalties. In addition to IRAs, which are typically opened and managed independently, you may have access to tax-deferred savings through an employer-sponsored retirement plan, such as a 401(k), 403(b) or 457 plan.
Pre-tax vs. after-tax deductions
Don't confuse a traditional IRA or 401(k) with a Roth-designated account. Roth IRA and Roth 401(k) accounts are funded with after-tax dollars, and future withdrawals are tax-free. If you save in a Roth IRA savings account, you won't owe interest on qualified withdrawals.
Taxes on savings account withdrawals
With a standard savings account, you can withdraw funds at any time without penalties. You'll usually have to pay income taxes on the taxable income earned, regardless of whether you withdraw.
Penalties on tax-deferred savings account withdrawals
The rules are different for tax-deferred savings accounts. You may incur penalties if you withdraw from a tax-deferred account outside of approved scenarios.
For example, most retirement accounts require you to wait until you're 59 ½ years old to withdraw.1 If you withdraw before that age, you'll generally owe a 10% penalty, outside of some rare exceptions. You may also be penalized if you don't withdraw a required minimum distribution (RMD) starting at age 72, depending on your birth year.2 An RMD is a required amount you have to withdraw based on your account balance and age. After you make a withdrawal, a savings account could be the best place to deposit your funds.
When in doubt, work with a tax professional to ensure you don't accidentally owe unexpected taxes.
Tax Advantages of Savings Accounts
Most savings accounts don't come with major tax advantages. However, you may be able to lower your total taxable income—effectively wiping out your taxes from savings account interest, among other sources—with tax deductions. Deductions lower your taxable income, so you'll pay taxes as if you had earned less than you did.
Tax credits are even more valuable, as they directly lower the taxes you owe at the end of the year. It's always important to capture all available deductions and credits to pay the least tax on your income.
Managing Taxes on Savings Accounts
While the interest you earn on a savings account may be taxable, that's not necessarily bad. If you owe a lot of taxes due to a savings account, it's because you earned a lot of interest during the year. For 2023, tax rates on savings accounts range from 10% to 37%, depending on your total income.3
The safety of a savings account makes it an excellent place to store funds for various reasons, such as emergency savings or a down payment on a house. With a high yield savings account, your cash is hard at work earning money for you while you sleep. Plan on paying taxes on those earnings unless your cash is stored in a tax-deferred savings account.
Eric Rosenberg is a financial writer, speaker and consultant based in Ventura, California. He holds an undergraduate finance degree and an MBA in finance. He is an expert in topics including banking, credit cards, investing, cryptocurrency, insurance, real estate and business finance.
LEARN MORE:Tax Credits vs Deductions: Key Differences and Similarities
