Do you have to pay tax on the interest on your savings account?
Many savings accounts, certificates of deposit and money market accounts have seen significant interest rate hikes in 2022 as the Federal Reserve has exceeded the federal funds target range.
Around this time last year, the best high yield savings accounts gained on average about 0.5% to 1%. In late 2022, you can find online banks offering savings accounts with APYs of 3% and above.
As long as the Fed keep raising ratesHigh Yield Savings Account rates will continue to rise.
But all this interest is not free money. You must pay taxes on savings account earnings.
Here’s how it works.
Are savings accounts taxable?
Interest earned on a savings account is considered taxable income by the Internal Revenue Service. This means you have to report it on your tax return.
This includes interest earned on:
If you earned $10 or more in interest on your savings account this year, you will receive tax form 1099-INT from your bank or credit union by January 31.
How is interest income from savings accounts taxed?
Savings account interest is taxed at your marginal tax rate, also known as the earned income tax rate. This can range from 10% to 37%, depending on your tax bracket.
Here are the 2022 marginal tax rates (used when filing your taxes in 2023) for reference.
Marginal tax rates 2022
|Tax bracket||Single registrant||Married couple filing jointly|
|ten%||Up to $10,275||Up to $20,550|
|12%||$10,275 to $41,775||$20,550 to $83,550|
|22%||$41,775 to $89,075||$83,550 to $178,150|
|24%||$89,075 to $170,050||$178,150 to $340,100|
|32%||$170,050 to $215,950||$340,100 to $431,900|
|35%||$215,950 to $539,900||$431,900 to $647,850|
|37%||Over $539,900||Over $647,850|
Your taxable income for the year determines your tax rate for interest income. So if you fall in the 22% tax bracket, all savings account interest is taxed at 22%.
Interest earned in 2022 must be reported when you file your taxes in 2023.
A few things to keep in mind:
- The IRS taxes annual percentage returnor APY, from the savings account as well as any login bonuses you may have received.
- You are only taxed on the interest you have earned: you are not taxed on everything money from your savings account. (If you earn $20 after depositing $5,000 in a high-yield savings account, you’ll only have to pay tax on $20.)
- Interest is still considered taxable income, even if you don’t withdraw it from your savings account.
- If your modified adjusted gross income is greater than $200,000 ($250,000 for married couples) in 2022, you are also subject to net tax on investment income. This tax applies at the rate of 3.8%.
How to calculate your tax bill
To find out how much tax you will have to pay, take the amount shown on your 1099-INT and multiply it by your marginal tax rate.
This will give you an idea of the additional taxes you owe, said Erik Goodge, certified financial planner and chairman of the uVest advisory group in Newburgh, Indiana.
“For most people, this will be negligible unless they have large sums of money in savings accounts,” Goodge said.
How to report savings account interest at tax time
Before January 31, your bank or financial institution will send you a Form 1099-INT if you earned $10 or more in interest. You will report this amount as taxable income on your return.
The IRS will not be aware of interest income if your bank does not issue a 1099-INT. Yet you are supposed to report everything interest earned in the year, even if it is only a few dollars.
“You should still report it because lying is wrong,” said Robert Persichitte, CPA at Delagify Financial in Arvada, Colorado.
“For most people, it will be the difference of $3 or less, which is not worth cheating on,” he added.
Also, don’t assume that your 1099-INT hasn’t been issued. Although banks are not required to issue the form for interest income under $10, many make it available online.
According to Persichitte, you should look for a 1099-INT even if you think your interest income is less than $10.
“Some customers have been surprised that a sign-up bonus, discount or referral bonus is considered interest and should be reported,” Persichitte said.
How to Avoid Tax on Savings Accounts
There really is no such thing as a tax-free savings account.
But if you’re trying to avoid paying taxes on your savings and investments, there are a handful of accounts with tax advantages.
None of them is a traditional savings account, where you can easily transfer money whenever you want without penalty.
But if you’re looking to save money on taxes — or defer them until later — you have options.
401(k) and IRAs
Traditional 401(k)s and traditional individual retirement accounts allow you to defer taxes until you withdraw money from the account. Contributions also help reduce your taxable income in the year they are made.
With a Roth IRA or Roth 401(k), you invest money after paying taxes on it, so you won’t owe income taxes when you withdraw funds later. The compromise? Roth contributions do not reduce your taxable income for the year.
IRAs and 401(k)s are investment accounts, not savings accounts. Your money will grow as the stocks and mutual funds inside the account go up in value. They do not earn interest like a savings account.
You will face a tax penalty from the IRS for withdrawing funds from traditional retirement accounts before age 59.5.
EE series and Series I Bonds of the US Treasury Department accrue interest like a savings account. The difference: you can choose to differ pay taxes on that interest until you redeem the bond.
Alternatively, you can choose to pay interest taxes each year when you file your annual tax return. The choice is yours.
Government Savings Bonds are not subject to state or local tax. And if you use the money for higher education, you may be able to avoid paying federal income tax entirely on the interest on your savings bonds.
Health savings accounts
A health savings account is not like a traditional savings account. You can only use the money for eligible healthcare expenses, or you’ll face a 20% penalty from the IRS. (This penalty disappears when you reach 65).
HSAs accrue interest, but the rates are usually very low. You usually need to maintain some balance to get a better APY. HSA Bankfor example, offers 0.05% on accounts under $5,000.
If you manage to accumulate significant interest, you do not need to pay tax above.
Rachel Christian is a Certified Personal Finance Educator and Senior Writer for The Penny Hoarder.