Are high-yield savings account interest taxable?

Are high-yield savings account interest taxable?

Now is the Time to Earn on Your Savings Account: Understanding Taxes on Savings Account Interest

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Are you looking for a way to make some extra cash? Well, now is the perfect time to earn interest on your savings account! Despite the Federal Reserve leaving rates unchanged in September, rates are still at a 22-year high. High-yield savings accounts are offering interest rates of over 4%, and some banks even go above 5%. However, before diving into these lucrative savings options, it’s crucial to understand how the interest earned on your savings account is taxed.

High-Yield versus Regular Savings

First, let’s differentiate between regular savings accounts and high-yield savings accounts. The latter offers a higher interest rate than traditional savings accounts. Both types of accounts’ interest earnings are considered taxable income, but the high-yield savings account attracts a higher tax since the interest earned is generally greater. On the flip side, you’ll be accumulating more money in your high-yield savings, usually within an FDIC-insured account. Thus, it’s essential to consider the pros and cons of having a high-yield savings account.

How Savings Account Interest is Taxed

While your principal account balance in a savings account is not taxable, any interest earned is considered taxable income. The IRS taxes interest from high-yield savings accounts at the same rate they tax other forms of income. The amount of tax owed on interest income is based on your federal income tax bracket. Generally, the higher your income, the higher your tax bracket, and the more tax you could owe on your interest earnings.

The IRS adjusts federal income tax brackets annually for inflation, so there’s good news — you could pay a lower tax rate for 2023 than you did last year. For instance, if you had $10,000 in interest income and your marginal tax rate regarding your 2023 federal income tax bracket is 22%, the tax on your savings account interest would amount to $2,200.

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On the other hand, if you have $20,000 in a high-yield savings account earning 3.75% interest, you would only be taxed on the $750 interest earned, not the principal balance of $20,000.

It’s important to note that some individuals might be subject to an additional 3.8% tax called the Net Investment Income Tax (NIIT). This tax applies to capital gains, rental property income, and dividend income for filers with higher incomes.

If you’re curious about the federal marginal tax rates for 2023, refer to the table below:

How Much Savings Account Interest Income is Taxable?

All the interest earned from a high-yield savings account is taxable. Financial institutions will send you a Form 1099-INT once you earn more than $10 in interest. However, the IRS still requires you to report any savings interest earned, even if the amount is below the ten-dollar threshold. You must report savings account interest income on your tax return in the year it was earned.

Keep in mind that you might also need to pay state-level income tax on interest earned. Most states consider interest from high-yield savings accounts as taxable income. While states like New Hampshire have no income tax, they may still impose a special income tax for interest income.

Avoiding Taxes on Savings Account Interest

Unfortunately, federal income tax cannot be avoided on interest earned from high-yield savings accounts, unless you earn less than $10. However, there are strategies to avoid tax on certain types of savings accounts. It’s important to note that avoiding tax might impact how you can utilize your earnings. Here are a few tax-free options for accruing interest on your savings account:

Education Savings Account: Interest earned from Series EE or I bonds may not be taxable when used to pay for qualifying education expenses. Moreover, interest earned from a 529 savings plan may be tax-free when the earnings are withdrawn to pay for qualified expenses.

Health Savings: A health savings account (HSA) can earn interest, which is tax-free as long as the funds are used to pay for qualified health expenses. However, it’s vital not to exceed your HSA contribution limit, as you could face penalties.

Retirement Savings: Interest earned from a traditional IRA or 401(k) is not tax-free, but you may avoid taxes until later. Contributions and interest in these retirement accounts are not taxed until withdrawals are made.

Is a High-Yield Savings Account Worth It?

Despite the downside of paying taxes on earned interest, there are numerous benefits to having a high-yield savings account that may outweigh the negatives:

1. Your savings can earn significantly more money compared to other types of savings accounts.
2. You have flexibility in spending your earnings from a high-yield account.
3. By law, you can withdraw your money up to six times per month without facing penalties.

It’s advisable to consult with a trusted tax professional or financial planner to determine whether a high-yield savings account aligns with your financial goals. Additionally, ANBLE provides coverage of the best no-fee high-yield savings rates for 2023, if you decide to explore that option.

Related Content

• 2022-2023 Federal Tax Brackets and Income Tax Rates
• Types of Savings Accounts Explained
• Are I Bonds Taxable?

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