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Guide to Taxes on Savings Accounts

Guide to taxes on savings accounts
Austin Kilham
Austin KilhamUpdated January 30, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Whenever you make money, the federal government tends to get in on the action by taxing your gains. That generally includes the interest you earn on your savings account. While the annual percentage yield (APY) on regular savings accounts is relatively low, it is considered taxable income by the internal revenue service (IRS). It’s possible to minimize paying taxes on interest with the help of certain tax-advantaged accounts used to fund retirement, healthcare, and education expenses. However, these accounts generally aren’t designed for general, short-term savings goals, like building an emergency fund or buying a new car.Here’s what you need to know about your savings accounts and taxes, and which accounts to consider when looking for tax advantages. 

Do You Have to Pay Taxes on a Savings Account? 

Generally, yes – but only on the interest you earn, not on the principle. To understand how savings accounts are taxed, it can help to understand how these accounts work.Savings accounts are accounts held at banks or other financial institutions that offer a secure place for you to hold your cash. Funds in savings accounts are federally insured up to $250,000 per depositor, per ownership category, at insured banks and credit unions. Using a savings account allows you to separate your everyday spending money (kept in your checking account) from money that's meant for a later date, like an emergency or a vacation. Unlike most checking accounts, savings accounts also typically earn interest. While you do not pay taxes on the money you deposit into your savings accounts (you’ve likely already paid income taxes on those funds through withholding or making estimated tax payments), the interest you earn is another story. Since interest is income, it needs to get reported to the IRS and you may have to pay income taxes on it. If the bank gave you a sign-on bonus for opening the account, that’s considered taxable income as well.

Do You Pay Tax on Savings Account Interest?

Typically, yes. Any interest earned on a savings account is considered taxable income by the IRS and must be reported on your tax return. That includes interest earned on traditional savings accounts as well as high-yield savings accounts, certificates of deposits (CDs), and money market accounts. There are, however, some savings accounts that come with tax advantages (more on that below).

How Savings Accounts Are Taxed

The IRS considers interest you earn on a savings account to be taxable income, whether you keep the money in the account, spend it, or transfer it to another account. When the bank deposits the interest into your account, you will need to report that interest as income for that tax year. The IRS taxes interest based on your marginal income tax rate, which is calculated based on ordinary income. Therefore, the amount of tax you’re responsible for changes with your tax bracket. 

Reporting Savings Accounts on Your Taxes

If you earn more than $10 in interest during the tax year, your bank will likely send you a form 1099-INT, which shows the amount of interest that you earned. Sometimes, it will be part of a larger statement from a broker.These forms typically go out in late January. In other words, you’ll get your 2022 1099-INT early in 2023 and your 2023 1099-INT in early 2024. The amount of interest listed on this form is the amount you need to report as taxable income. Recommended: How to Pay Your Taxes With a Credit Card 

How to Pay Less Tax on Your Savings 

The government generally likes to encourage savings, so it offers a number of tax-advantaged ways of doing so. Here’s a look at some of your options.

Traditional IRAs

Individual retirement accounts (IRAs) are personal retirement savings accounts that offer tax benefits and a range of investment options. There are no income limitations but there are contribution limits: These are $6,000 ($7,000 if you’re age 50 or older) in 2022, and $6,500 ($7,500 if you’re age 50 or older) in 2023. Traditional IRA contributions are made with before-tax dollars, which means they lower your taxable income in the year you make them. Once your funds are inside the IRA, you can invest them in stocks, bonds, and other investment vehicles. The rate of return you earn depends on the investments you choose.Unlike interest earned in regular savings accounts, you won’t pay taxes on this interest right away. The returns you make inside an IRA are tax-deferred. This means you won’t pay taxes on the interest (or the money you originally invested) until you withdraw funds, which you can do penalty-free after age 59 1/2. Recommended: Is Using an IRA to Pay Student Loans a Good Idea? 

401(k)s

Traditional 401(k)s offer the same tax benefits as traditional IRAs, meaning contributions and earnings are tax-deferred. The main difference between these two types of retirement accounts is that employers offer 401(k)s, while individuals open IRAs (using brokers or banks).IRAs typically offer more investment options than 401(k)s. However, 401(k)s allow higher annual contributions. Individual 401(k) contribution limits are $20,500 in 2022 and $22,500 in 2023 ($27,000 and $30,000 for those age 50 or older).

Roth IRAs

Roth IRAs are similar to traditional IRAs in terms of contribution limits and investment options. The key difference: Contributions are made with after-tax dollars. This means that putting money into a ROTH IRA doesn’t reduce your taxable income for that tax year. Withdrawals, however, are tax-free after age 59½. As long as you don’t withdraw the money early, you won’t pay tax on any interest or investment returns you earn in your ROTH IRA account.Unlike traditional IRAs, Roth IRAs have income limits. For single filers, the limit is $144,000 for 2022 and $153,000 for 2023; for married couples filing jointly, it’s $214,000 in 2022 and $228,000 in 2023.

529 Plans

If you’re looking to save for education-related expenses (such as tuition for elementary, middle, or high school, or for college) a 529 plan is a tax-advantaged option. With these plans, you contribute post-tax dollars into your investment account and then see your investments grow tax-free.When the time arrives to pay for qualified education expenses, the withdrawals you make from the account come to you tax-free. If you withdraw earnings from the account for a non-qualified expense, however, you must pay applicable taxes, as well as a penalty.Recommended: Analyzing the Cost of College Over Time 

Health Savings Accounts (HSAs)

A health savings account (HSA) can help you save for healthcare expenses and also get some tax advantages. If you have an employer-sponsored account, your contributions are taken out of your paycheck before taxes. If you set up your own HSA, the money you put in is tax-deductible. Your HSA money can be invested in mutual funds, stocks, and other investment tools, and any growth is tax free. As long as you use your HSA money for eligible medical expenses, you'll pay no taxes on withdrawals.To be eligible to open an HSA, you need to be enrolled in a high-deductible health insurance plan and not receive Medicare.

Municipal Bonds

Municipal bonds are used by state and local governments to fund projects, such as building new schools and other public infrastructure projects. When you buy a bond, you are essentially loaning money to the government for a set period of time. In return, you receive a nearly-guaranteed rate of return through interest payments twice a year. The interest paid on municipal bonds is generally tax-exempt from federal taxes and, if those bonds are issued by the state you live in, from state and local taxes as well.

The Takeaway

While savings accounts are not generally thought of as investments, you typically do earn money from them in the form of interest. The IRS considers the interest you earn on these accounts to be taxable income.There are some ways to minimize taxes on interest. Certain accounts, such as those designed to encourage savings for retirement, education, and medical costs, exempt interest from taxes both when it is earned and, often, when it is withdrawn. However, these accounts typically have strict rules regarding when and how you can use the funds. Savings accounts, especially the top high-yield savings accounts can still be useful for emergency savings and short-term saving goals.If you're interested in finding the best rate for your savings, Lantern by SoF can help. With our online banking marketplace, it’s easy to compare high-yield savings accounts based on APY, fees, and balance minimums.Lantern can help you compare online savings accounts and find today’s best rate.

Frequently Asked Questions

Do I have to pay taxes for my savings account?
How much money can you have in your savings account without being taxed?
How can I avoid paying taxes on my savings account?
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About the Author

Austin Kilham

Austin Kilham

Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
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