Many savings accounts, certificates of deposit and money market accounts have enjoyed sizable interest rate bumps in 2022 as the Federal Reserve edges the target federal funds range higher.
Around this time last year, the best high-yield savings accounts earned an average of about 0.5% to 1%. As 2022 comes to a close, you can find online banks offering savings accounts with APYs of 3% and higher.
As long as the Fed keeps raising rates, high-yield savings account rates will keep inching higher.
But all that interest isn’t free money. You have to pay taxes on savings account earnings.
Here’s how it works.
Are Savings Accounts Taxable?
Interest earned on a savings account is considered taxable income by the Internal Revenue Service. That means you need to report it on your tax return.
This includes interest earned from:
If you earned $10 or more in interest from your savings account this year, you’ll receive tax form 1099-INT from your bank or credit union before Jan. 31.
How Is Interest Income From Savings Accounts Taxed?
Savings account interest is taxed at your marginal tax rate, also known as your earned income tax rate. This can range from 10% to 37%, depending on your tax bracket.
Here are the 2022 marginal tax rates (used when filing your taxes in 2023) for reference.
2022 Marginal Tax Rates
|Tax Bracket||Single Filer||Married Couple Filing Jointly|
|10%||Up to $10,275||Up to $20,550|
|12%||$10,275 to $41,775||$20,550 to $83,550|
|22%||$41,775 to $89,075||$83,550 to $178,150|
|24%||$89,075 to $170,050||$178,150 to $340,100|
|32%||$170,050 to $215,950||$340,100 to $431,900|
|35%||$215,950 to $539,900||$431,900 to $647,850|
|37%||Over $539,900||Over $647,850|
Your taxable income for the year determines your tax rate for interest income. So if you fall into the 22% tax bracket, all savings account interest gets taxed at 22%.
Interest earned in 2022 must be reported when you file your taxes in 2023.
A few things to keep in mind:
- The IRS taxes the annual percentage yield, or APY, of the savings account along with any sign-on bonuses you may have received.
- You’re only taxed on the interest you earned: You’re not taxed on all the money in your savings account. (If you earn $20 after depositing $5,000 in a high-yield savings account, you’ll only owe taxes on $20.)
- The interest is still considered taxable income, even if you don’t withdraw it from your savings account.
- If your modified adjusted gross income is more than $200,000 ($250,000 for married couples) in 2022, you’re also subject to net investment income tax. This tax applies at a rate of 3.8%.
How to Figure Out Your Tax Bill
To figure out how much you’ll owe in taxes, take the amount listed on your 1099-INT and multiply it by your marginal tax rate.
This will give you an idea of the additional taxes you owe, said Erik Goodge, a certified financial planner and president of uVest Advisory Group in Newburgh, Indiana.
“For most people, this will be negligible unless they have large amounts of money in savings accounts,” Goodge said.
How to Report Savings Account Interest at Tax Time
By Jan. 31, your bank or financial institution will send you a form 1099-INT if you earned $10 or more in interest. You’ll report that amount as taxable income when you file.
The IRS won’t know about the interest income if your bank doesn’t issue a 1099-INT. Still, you’re supposed to report all interest earned in the year — even if it’s just a few dollars.
“You should still report it because lying is bad,” said Robert Persichitte, a certified public accountant at Delagify Financial in Arvada, Colorado.
“For most people, it’ll be the difference of $3 or less, which isn’t worth cheating,” he added.
Don’t assume your 1099-INT wasn’t issued, either. While banks aren’t required to issue the form for interest income under $10, many make it available online.
According to Persichitte, you should look for a 1099-INT even if you think your interest income is less than $10.
“Some clients were surprised that a signup bonus, rebate or referral bonus counted as interest and needed to be reported,” Persichitte said.
How to Avoid Tax on Savings Accounts
There’s really no such thing as a tax-free savings account.
But if you’re trying to avoid paying taxes on your savings and investments, there’s a handful of accounts with tax advantages.
None of them are traditional savings accounts, where you can easily transfer money in and out whenever you want without a penalty.
But if you’re looking to save money on taxes — or defer them until later — you’ve got options.
401(k) and IRAs
Traditional 401(k)s and traditional individual retirement accounts let you defer taxes until you withdraw money from the account. Contributions also help lower your taxable income in the year they’re made.
With a Roth IRA or Roth 401(k), you’re investing money after you pay taxes on it, so you won’t owe income taxes when you withdraw funds later. The trade off? Roth contributions don’t lower your taxable income for the year.
IRAs and 401(k)s are investment accounts, not savings accounts. Your money will grow when stocks and mutual funds inside the account gain value. They don’t earn interest like a savings account.
You’ll face an IRS tax penalty for withdrawing funds from traditional retirement accounts before age 59.5.
Series EE and Series I bonds from the U.S. Treasury Department accumulate interest like a savings account. The difference: You can elect to defer paying taxes on that interest until you cash in the bond.
Alternatively, you can choose to pay taxes on the interest each year when you file your annual income tax return. The choice is yours.
Government savings bonds aren’t subject to state or local tax. And if you use the money for higher education, you might be able to avoid paying federal income tax on your savings bond interest entirely.
Health Savings Accounts
A health savings account isn’t like a traditional savings account. You can only use the money for qualified health care expenses or else you’ll face a 20% penalty from the IRS. (This penalty goes away when you turn 65).
HSAs accumulate interest but the rates are usually very low. You typically need to maintain a certain balance to get a better APY. HSA Bank, for example, offers 0.05% on accounts with less than $5,000.
If you manage to accumulate any notable interest, you don’t need to pay taxes on it.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.