In this article:
- How Are Savings Accounts Taxed?
- How to File Taxes on Savings Account Interest
- Tax-Free Alternatives to Savings Accounts
If this was the year you finally stashed a few dollars into a savings account, that's good news for you. Even better, interest rates on savings accounts are up, with many high-yield savings accounts paying more than 3%. Be aware, though, that any interest earned on a traditional or high-yield savings account—as well as certificates of deposit and money market accounts—is considered taxable income by the IRS. Here's what to know about paying taxes on your savings account.
How Are Savings Accounts Taxed?
Savings account interest is taxed at the same rate as your earned income. The interest you earn on regular savings, high-yield savings, money market accounts or certificates of deposit is reported to the IRS on Form 1099-INT. You should receive a separate 1099-INT from every financial institution with which you hold an interest-earning account, so if you have a regular savings account with your local credit union and a high-yield savings account at an online bank, look for two 1099-INT forms in the mail. You should receive a copy of your 1099-INT forms in late January or early February, in time to use them to file your taxes.
Good news: Your savings account interest is taxable but your savings account balance is not. If you have $10,000 stashed away in a high-yield savings account earning 3%, you'll be taxed on your $30 of interest, not your $10,000 in savings.
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How to File Taxes on Savings Account Interest
You're required to report any interest you've earned to the IRS on your tax return. Your bank or credit union will issue a 1099-INT form in late January if you've earned at least $10 in interest during the year. They'll also send a copy to the IRS.
Use 1099-INT forms to report your savings account interest accurately on your tax return, but don't overlook interest you've earned that wasn't reported on a 1099-INT, even if it only added up to a few dollars or cents. Bank statements typically show year-to-date interest if you haven't earned enough to trigger a 1099-INT, or if you want to double-check the information reported on your 1099-INT.
Savings account interest is part of your adjusted gross income on your tax return. If you have more than one interest-earning account, add up your interest for the year and include it as a total under "taxable interest" on Form 1040. If your taxable income and dividends total more than $1,500, use Schedule B to list out each source of interest and the amount earned during the year.
You don't have to submit 1099-INT forms with your tax return; the IRS already receives this information from your bank or credit union. However, make sure your numbers match up. The IRS reviews tax returns for errors and omissions, and they'll contact you if your 1099-INT totals don't match the totals they've received from your financial institutions.
Tax-Free Alternatives to Savings Accounts
The IRS allows you to earn interest tax-free or tax-deferred on certain types of savings accounts. If you want to save money but don't want to pay taxes on interest, here's a quick rundown of options to consider:
- Traditional IRA or 401(k): Traditional IRAs and 401(k)s let you save for retirement using pretax dollars. This means the money you contribute to a traditional retirement account is tax deductible in the year you deposit it. You don't pay taxes on earnings and interest for as long as your money stays in the account, but you will pay regular income taxes on qualified withdrawals in retirement. Early withdrawals (made before age 59½) may be subject to penalties.
- Roth IRA or Roth 401(k): Contributions to Roth IRA and Roth 401(k) plans are not tax deductible, but your earnings and interest are tax-free for as long as your money stays in the account. When you make qualifying withdrawals in retirement, that money is also tax-free. The rules for withdrawing money from a Roth account are more flexible than they are for traditional IRAs, but check with your account provider for details to avoid penalties.
- Health savings account (HSA): HSAs allow you to save money toward health insurance deductibles and other unreimbursed medical and dental expenses tax-free. Your HSA contributions are deductible in the year you contribute. Withdrawals are also tax-free, as are earnings and interest earned on your HSA account.
- 529 education savings plans: Saving for college or private K-12 tuition in a tax-advantaged 529 account? You won't pay taxes on your interest and earnings, and as long as you use the money for qualified education expenses, you won't pay taxes on your withdrawals either. In 30 states, 529 contributions make you eligible for tax credits or deductions on your state tax return.
The Bottom Line
Although paying taxes on savings account interest may eat into your profits, the majority of your interest earnings will be yours to keep. Meanwhile, accumulating money in a savings account is a good financial practice—to deal with emergencies, save for large purchases and give yourself options when you're ready to send your kids to college or retire.
If you're looking to optimize your overall finances, consider revisiting your monthly budget and checking your credit report and credit score. Good money habits can put you on track to save more money and meet your tax obligations as you go.
