How CDs Are Taxed: Tax Planning Guide

Certificates of deposit (CDs) offer a predictable way to earn interest, but understanding how taxing CDs work can help avoid surprises at tax time. The IRS treats interest earned on CDs as taxable income, even if it remains in the account and isn’t withdrawn. Most banks report this interest annually on a Form 1099-INT, and it is typically taxed as ordinary income based on the account holder’s tax bracket. While traditional CDs generate taxable interest each year, tax-advantaged accounts like IRAs may allow deferral of taxes on CD earnings, depending on the type of account and contributions made.

A financial advisor can help you optimize your financial plan to potentially lower your tax liability. Match with a fiduciary advisor who serves your area.

What Are CDs and How Do They Work?

A CD is a fixed-term savings accounts offered by banks and credit unions that pay interest in exchange for leaving funds untouched for a set period. Unlike regular savings accounts, CDs typically offer higher interest rates but impose penalties for early withdrawals. The term length can range from a few months to several years, with longer terms often yielding higher rates.

When opening a CD, the account holder agrees to a fixed interest rate and maturity date. Interest accrues over time, and at maturity, the depositor can either withdraw the funds or roll them into a new CD. Banks may offer different types of CDs, including traditional and high-yield accounts, each catering to different financial goals.

While you can take money out early before the end of your CD’s term, you’ll have to pay a penalty of varying severity depending on the financial institution, terms of your agreement, and the length of time you left the money in the CD. The exception to this rule is the no-penalty CD.

Do You Pay Taxes on CD Interest?

CD interest is considered taxable income in most cases, even if the funds remain in the account and are not withdrawn. The IRS requires that earned interest be reported annually, meaning taxes may be due on the interest before the CD matures. This is because CDs accrue interest over time, and banks typically report these earnings each year on Form 1099-INT if the total interest exceeds $10.

The way interest is taxed depends on when it is credited. For CDs that compound annually or monthly, the interest earned in a given year is taxable, regardless of whether it is withdrawn. Even if a CD has a multi-year term and interest is paid at maturity, the IRS may still require annual reporting based on accrued interest.

Tax treatment can vary for CDs held in tax-advantaged accounts, such as IRAs, where earnings may be deferred or exempt from taxes. However, for CDs in standard taxable accounts, interest is typically taxed as ordinary income at the account holder’s marginal tax rate.

How to Report CD Income on Your Tax Return

The institution that holds your CD will provide you with a 1099-INT statement at the beginning of the year that will detail your CD yield for the previous year. You’ll get this even if you didn’t cash out the money on your CD and instead invested it into a new CD. If your CD has a yield over $10, you’ll get a 1099. Your 1099s from all sources will be included in your tax return under Line 3 on a standard 1040 as “Other Income.”

You may need to include a Schedule B for “Interest and Ordinary Dividends” if you meet any of the IRS requirements, including having over $1,500 of taxable interest or ordinary dividends the prior tax year.

How to Avoid Tax on CD Interest

While CD interest is generally taxable, certain strategies can help defer or reduce tax liability. Here are some options to consider:

• Time CD maturity for lower tax years: CD laddering can help time interest payments for years when income is lower, potentially reducing the overall tax burden.
• Use tax-advantaged accounts: Holding CDs in a Traditional IRA allows interest to grow tax-deferred until withdrawals begin. Roth IRA CDs offer tax-free growth if withdrawals meet IRS requirements.
• Invest in municipal bonds: Unlike CDs, municipal bond interest is often exempt from federal income taxes and may also be state tax-exempt if issued by your home state. However, these bonds carry different risks than CDs.
• Consider U.S. Treasury securities: Treasury bonds and I bonds offer tax advantages. Treasury bond interest is exempt from state and local taxes, while I bond interest can be deferred until redemption.

Is Putting Money in a CD a Good Idea?

A CD is sometimes jokingly referred to as a “certificate of depreciation.” While CD interest rates are currently relatively high, so is inflation. Locking money into a CD guarantees a rate of return, but you may get a similar or better rate with a high-yield savings account or Series I savings bonds. While I bonds lock up your money for at least a year to get a return on your investment, a high-yield savings account keeps your money available in case of emergency while it goes to work for you.

Strategically moving around large sums of money to different accounts for new-customer signup bonuses can also net you a higher yield than a CD while keeping your money more accessible.

If you’re considering putting your money in a CD to protect it from market volatility and recession fears keep in mind that you may not want to pull out of investing entirely. Past performance can’t guarantee future results, but historically market downturns have been the best times for people to invest their money for long-term growth. Well-diversified investments can sometimes beat high inflation rates, but CDs almost never can.

Bottom Line

The interest rate your CD earns, called the yield, is taxed at your ordinary income tax rates. While CD rates are high now, consider alternative options like high-yield savings accounts to preserve access to your money or Series I Savings bonds, which may pay higher yields than a CD.

Tips on Taxes

• A financial advisor can offer insight and guidance as you work to handle your securities in a tax efficient way. 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.
• Use our no-cost income-tax calculator to get a quick estimate of what you will owe the federal government.

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