How Savings Accounts Are Taxed - SmartAsset

You are required to report and pay federal taxes on any interest income you receive from a savings account. The income is taxed as unearned, which means you’ll escape payroll taxes, but you will owe federal income tax on it at your regular rate. Banks and other financial institutions report your interest income on a form 1099-INT if it’s over $10. Consider talking to a financial advisor to understand how savings account interest income may be taxed.

Savings Account Taxes

The money you deposit to a regular savings account has already been taxed and you won’t owe taxes on it when you withdraw it to spend or invest. But interest on savings accounts is considered to be income by the Internal Revenue Service. This is so even if you don’t withdraw the interest from the account.

Interest paid to almost any bank account, including savings, checking, money market accounts and certificates of deposit, is taxable. Dividends on deposits or shared accounts at credit unions, cooperative banks, savings and loans and mutual savings banks are also included as taxable income.

The federal income taxes due on savings account interest are calculated as a percentage of your taxable income according to the current federal income tax brackets. These range from 10% to 37% depending on your income level.

Although you owe income taxes on savings account interest, the income is not considered earned income, such as wages and salary. As unearned income, it is not subject to payroll taxes, including Social Security and Medicare taxes. However, you may also owe state income taxes in addition to the federal levy.

While you will typically be charged a tax for any interest that is earned from your savings account, you won’t have to be taxed on the balance of the money you keep in your account. You should have paid tax on that money prior to putting the money in that account so it isn’t going to be taxed again just for sitting in the account.

How to File Your Earned Interest Taxes

The financial institution that holds your savings account is required to report to the IRS any interest payments totaling more than $10 for the year, using the 1099-INT form. The bank or other payer is required to send you a copy of the form by the end of January. You may receive it by mail or it may be available as a document accessible through your online account. The amounts on this form are needed to file your taxes properly.

Sometimes you may not receive a 1099-INT. However, this doesn’t relieve you of the responsibility for reporting and paying taxes on the interest. This is true even if the interest is less than $10. If it is less than $10, the bank won’t send a form. In that case, you may have to look through your account statements and add up all the interest you’ve received in order to know how much to report on your tax return. Failing to report any interest income could subject you to penalties and interest.

If the bank didn’t send you a 1099-INT because you didn’t provide a Social Security number when opening the account, you may be subject to backup withholding. When this happens, the bank will withhold 24% of your interest to pay any taxes due. You may also be subject to backup withholding if you provided an incurred Social Security number or have previously failed to file a return.

Savings Accounts That Don’t Tax Interest

Some banks offer a special type of savings account, called an IRA savings account, that allows you to deduct from your current income any deposits you make to the account. Interest income on these IRA savings accounts accrues without being taxed, as long as you don’t withdraw it.

Once you withdraw any money including interest from IRA savings, however, it becomes taxable as income. Also, if you withdraw from an IRA savings account before age 59 ½, you have to pay an additional fee.

Some savings accounts for education purposes, such as Coverdell savings accounts and 529 plans, also earn interest tax-free. You won’t pay taxes on interest from these accounts as long as the money is used for education. You can’t use the money in these accounts for non-educational purposes, which might make it tough for some if you’re looking to take money out of your savings for more reasons.

Your last option for getting a tax-exempt savings account is to open a health savings account (HSA) or a flexible spending account (FSA). Both are used to pay for healthcare-related expenses but have slightly different rules. A health savings account balance can be carried over from year to year, but you must have a high deductible health plan to open one. An FSA, on the other hand, has a balance that must be used by the end of the year.

Bottom Line

Savings account interest is taxed as income by the federal government. Interest earnings of more than $10 are reported to the IRS and to you by the bank or other institution where the money is deposited using a 1099-INT form. You are required to report all interest received on your tax return, however, even if it is less than $10 and whether or not you receive a 1099-INT. Interest income is free of payroll taxes, but you’ll pay income taxes on it at your ordinary rate.

Tips for Saving

A financial advisor can help you evaluate your tax situation. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You don’t have to utilize just a single savings account. In fact, you can use a number of accounts to help you with different things. For example, you may want to keep your emergency fund in a high-yield savings account but you may also want to open an HSA while keeping retirement savings in an IRA account. All of this can get complicated pretty quickly so you can use a savings calculator to help you figure out how much should be in each account.