Are Certificates of Deposit (CDs) Taxable?

By Caroline Banton · June 06, 2022 · 9 minute read

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Are Certificates of Deposit (CDs) Taxable?

Yes. Certificates of deposit (CDs), also known as term deposits or time deposits, are FDIC-insured savings accounts available at most banks. CDs earn interest on the principal deposited for a specific period of time, and that interest is taxable.

CDs come with certain restrictions. For example, you cannot access your money for a fixed period of time (e.g. 3 months, 1 year, 5 years). In exchange, CDs often pay more interest than a regular savings account, though the rates are typically low. In fact, many CD accounts don’t keep up with inflation, so once taxes are paid on the interest earned there may not be much of a return on your investment.

If you’re thinking of buying a CD, it’s important to understand how CDs work and how they are taxed.

What Is a Certificate of Deposit?

A certificate of deposit (CD), also known as a term deposit or time deposit, is a savings account that comes with certain rules and restrictions. The chief difference between a CD and a traditional savings account is that once you deposit funds, you can’t add to the account or withdraw from the account for the entire term of that CD, whether that’s three months or three years. In most cases, if the account holder withdraws the funds before the end of the term, they are charged a penalty.

During that time, however, the funds earn interest (be sure to understand the difference between simple interest and the APY or annual percentage yield), often a higher rate than a traditional savings account.

Are CD accounts taxed? Yes, account holders are taxed on the interest earned. The amount of interest paid depends on the amount deposited and the length of the CD term. Investing in CDs is a fairly conservative endeavor as they are low risk compared to other types of investments. That said, the interest earned on a CD is minimal, and can be reduced by the tax you might pay.

How Do Certificates of Deposit Work?

CDs are guaranteed funds for a bank because the account holder agrees not to withdraw the principal for a certain period (e.g. 6 months, 2 years, 5 years). The bank pays a fixed interest rate to the CD holder in return for using the funds to invest elsewhere to make a profit.

The advantage of a CD vs. a regular savings account with unrestricted withdrawals is that the CD earns a fixed interest rate that can be higher than a regular savings account.

The longer the CD’s term length, generally the higher the interest rate. However, the rate of return is still lower than other investments such as stocks or other riskier investments. Like bonds, CDs are considered relatively safe investments because they are low risk and pay a fixed rate of interest. Also, CD deposits are protected by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA) for up to $250,000 per person.

What Happens If a CD Is Redeemed Early?

Most CDs are subject to penalties if funds are withdrawn early. Each bank will set penalties differently, and they may include loss of principal and loss of interest earned. If the penalty charged by the bank exceeds the interest earned by the CD at the time of withdrawal, some of the principal may be used to make up the difference.

Recommended: How CD Early Withdrawal Penalties Work

What Counts as an Early Withdrawal?

How soon the money is withdrawn during the CDs term is significant. According to federal law, if the principal is redeemed in total within the first six days after depositing the money in a CD, a minimum penalty of at least seven days of simple interest is levied, but the total penalty charged by the bank will likely be more. It is possible to lose all of the earnings on the principal.

How Much Are Early Withdrawal Penalties?

Individual banks determine how much interest to withhold as a penalty for early withdrawals based on the CD’s term. The longer the term, the more interest will be charged. For example, some banks may charge a penalty of six months of interest on an 18-month-term CD. Others may charge a set fee of $25 plus 3% of the amount withdrawn.

Some banks will allow partial withdrawals from a CD, and some do not. Before opening a CD, the account holder should check the early withdrawal conditions set by the bank.

Are Penalties Tax Deductible?

Early withdrawals from CDs may reduce your total tax obligation because the penalty paid can be deducted from your taxes, even if the amount is more than the interest earned. For example, if you earned $100 interest but paid a penalty of $200, you can deduct the $200.

What Is a No-Penalty CD?

No-penalty CDs do exist and are known as liquid CD accounts. These often allow the CD holder to withdraw funds without a penalty within seven days of the initial deposit, after a certain period, or during the term, depending on the bank’s rules. However, the interest earned on these liquid accounts will be lower than regular CD accounts, and the bank may require a higher minimum deposit.

What Happens When the CD Term Ends?

When the CD term is up, some banks will automatically renew the CD. However, the account holder will be notified in case they would rather withdraw the funds and the interest earned.

If the account holder dies, the full face value of the CD is paid to the beneficiary with no early withdrawal penalties if the owner died prior to the maturity date.

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How Are Certificates of Deposit Taxed?

The interest earned on a CD is considered income by the Internal Revenue Service (IRS). That applies even if the money is rolled over to a new CD. The interest earned is taxable each year earnings are paid on the CD.

The bank will typically send CD holders a 1099-INT statement for any interest earned over $10, but taxes are due even if the investor doesn’t receive a 1099. The amount of tax you pay will depend on the amount of your earnings and your tax bracket. Also, CDs are taxes as interest income, not as capital gains, which can be a lower tax rate.

Taxes on Short-Term CDs

For a six-month CD purchased in one year, tax on any earnings over $10 will be due for that same year. The exception to this rule is if the CD is in a tax-deferred individual retirement account (IRA) or 401(k) — sometimes called an IRA CD.

If you open an IRA and the money you deposit is below the annual contribution limit, interest earned in a given year may be tax deferred (i.e. not taxed until funds are withdrawn in retirement).

How Is Interest Taxed on CDs?

When a CD matures, and if it is cashed in, only the amount above the initial investment is considered income. Here’s an example,

If you purchase a one-year CD for $15,000 and it pays 1% interest, in one year you will have earned roughly $150 (it’s slightly more with compounding). At maturity, the bank will give you $15,150, your original investment of $15,000 plus the interest of $150. You will only pay tax on the $150, and this is what will be shown on the 1099-INT.

Recommended: How Does Compounding Interest Work?

Preparing to Pay Taxes on a CD

•   Make a schedule of the timing and amount of taxes on your CD.

•   Here’s a formula to estimate the annual tax obligation on your CD interest:

   CD value x CD interest rate x your income tax rate = annual tax obligation

•   If you have CDs in a traditional IRA and you are required to make a required minimum distribution or withdrawal from the IRA, first calculate the amount of the RMD you will have to take that year. Second, calculate the income tax on that RMD.

•   Consider rolling over the RMD to a taxable CD outside of the IRA.

•   Consider setting up CDs that mature in time to make your tax payments. This is called a CD ladder, whereby one CD matures each year in an amount large enough to make the tax and/or RMD payments for that year.

For CDs with a multi-year term, the holder will pay taxes each year on the interest earned that year until maturity.

•   Calculate how much you earned in interest for each year on each CD.

•   Remember that if you own a CD with a three-year term, your account will be credited with interest in each of those three years. You will then owe tax each year even before you cash out or roll over the CD at the end of three years.

•   Check that your calculation matches the amount written on Form 1099-INT each year, notifying you of the amount of earned interest you owe taxes on that year.

The Takeaway

So are CD accounts taxable? In effect yes, because the interest earned can be taxed. The amount of tax due will depend on the amount of earnings and the account holder’s tax bracket.

Certificates of deposit (CDs) are FDIC-insured savings accounts available at most banks. CDs generally earn more interest than a regular savings account, but the rates are typically low and can vary depending on the length of the term and the amount of the deposit. Also, CDs do not keep up with inflation, so once taxes are paid on the interest earned, there may not be much of a return on the investment.

CDs are subject to penalties if funds are withdrawn early. If the penalty charged by the bank exceeds the interest earned by the CD at the time of withdrawal, it’s possible to lose all the earnings on the principal (but these penalties are tax deductible, which may help make up for some of the loss).

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Are CD accounts taxed?

Yes. CD holders must pay taxes on any interest earned on a CD.

How much is the tax on a CD?

The amount of tax due will depend on the amount of earnings and the account holder’s tax bracket. CDs are taxed as interest income, not as capital gains, which can be a lower tax rate.

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SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

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