How Are Savings Accounts Taxed?

A savings account is a secure place to keep your cash while earning interest, but any amount of interest you earn from a savings account is usually taxable.

You are required to report any interest earnings from most savings accounts to the IRS. If the yearly earned interest is $10 or more, your bank or financial institution will send a Form 1099-INT to the IRS and provide you with a copy, which you use to report interest income on your tax return.

Here’s a closer look at how taxes affect different types of savings accounts.

A Quick Refresher on Savings Accounts

A typical savings account is a place where you can deposit money not meant for everyday expenses. You might use one to set funds aside for emergencies or a dream vacation. Savings accounts differ from checking accounts in that they tend to offer a higher annual percentage yield (APY), so you can earn a modest interest while saving for the future.

There are different types of savings accounts. A typical savings account can be independent or attached to a checking account. A certificate of deposit (CD) is a savings account that earns interest on a set amount of money for a (typically) fixed period of time. Almost all savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC), which covers deposits in the event of a bank failure. Generally up to $250,000 per depositor, per account ownership category, per insured bank is covered at FDIC-insured financial institutions.

Most savings accounts can be opened online, over the phone, or in person at a bank or credit union. Steps to opening a savings account can include:

•   Providing proof of identification: You’ll need a valid ID number, such as a Social Security number, Individual Taxpayer Identification Number, passport number, or other government-issued identification.

•   Providing personal details: You may be asked to give information such as your legal name, address, phone number, email address, and date of birth.

•   Selecting the type of account: You can usually choose between a single or joint savings account. Some banks may offer a selection of savings accounts with varying rates and terms.

•   Making your initial deposit. Once your application is completed and approved, some financial institutions will require an initial deposit, which may be about $25 to $100 at banks and $5 at credit unions, although some accounts require lower or no minimums at all.

Other types of savings accounts or savings plans may require additional steps and information.

What’s Taxable in Savings Accounts?

Earned interest on your savings account is almost always taxed. It will be reported on a 1099-INT form if it equals $10 or more per year, but you should report it even if it’s under $10. Here’s a closer look at what can be taxed.

Earned Interest Taxes

Any interest you earn on a savings account is taxable, whether it’s $600 dollars a year or $1.00. The interest is generally taxed according to your income tax bracket for the year.

Promotional Bonuses

Some savings accounts offer promotional bonuses for opening the account. Unfortunately, these bonuses usually count as taxable income. You must report them to the IRS, and your bank may report them on Form 1099-INT or 1099-MISC.

If the thought of paying taxes on your savings has you clutching your piggy bank, know this: A savings account is still a good idea, in most cases, since it provides a secure place to save money for your goals and earn interest while allowing easy access to your funds.

Which Savings Plans Are Tax-Advantaged?

As mentioned above, the interest in a typical savings account is taxable. Knowing how different types of savings accounts or savings plans are taxed may help you reach your financial goals.

For example, if you have $10,000 in a high-yield savings account with a 4.00% APY, you will be paying taxes on approximately $400 of earned interest for the year (assuming no additional deposits or withdrawals).

However, not all savings plans are taxed the same. There are other types of savings vehicles that are tax-advantaged in certain ways. For example, with certain investment accounts designed to help you save for education costs or retirement, you can contribute after-tax money and may be able to make tax-free withdrawals later, depending on factors such as age or how the funds are used. Conversely, tax-deferred accounts allow earnings to grow without immediate taxation, with taxes typically paid when withdrawals are made in the future.

Importantly, though, these plans are different from typical savings bank accounts in that they may not be insured by the FDIC, and may be subject to investment risk, including the potential total loss of principal.

There are different ways these savings plans may be tax-advantaged. Here are common types of savings plans that offer tax benefits.

Types of Savings Plans That Are Tax-Advantaged

Some savings plans are designed for specific goals and come with tax benefits that may help you reach those goals. These may include plans that can be used to save for retirement, send a child to college, and cover health care costs. These plans may offer a potential higher rate of return but come with higher risks, and may have rules about when and how you can access your funds in order to avoid paying a penalty.

IRAs

An IRA, again, is an individual retirement account that offers certain tax advantages. Contributions to your IRA may be invested in stocks, bonds, CDs, and other assets.

An IRA is different from a savings account in that it’s meant to serve as a long-term investment. The funds you contribute to your plan may be subject to the highs and lows of the stock market over time. Historically, the average rate of return is 7%, taking inflation into account, which can be significantly higher than the interest rate of a savings account.

However, unlike a savings account with a bank, an IRA may include investments (such as stocks) that carry the risk of loss, including the potential to lose your principal, as well as any gains. In addition, barring certain exceptions, penalties will apply if you withdraw funds before the age of 59½.

There are two types of IRAs:

•   Traditional IRA: Contributions to a traditional IRA are made with pre-tax dollars up to an annual limit. This money may then grow tax-deferred within the account. These contributions are typically tax-deductible, meaning they can lower your taxable income in the year you make them. You will need to pay taxes on both the principal and earnings later, however, when you withdraw the money in retirement.

•   Roth IRA: Contributions to a Roth IRA are made with after-tax dollars, and qualified withdrawals are tax-free on both contributions and earnings. In most cases, this means you must be at least age 59½ and have held the account for five years. As with a traditional IRA, you can only contribute up to the limits determined by the IRS each year.

529 Plans

529 plans are designed to help you save specifically for educational expenses, such as college for your children or for yourself. Like an IRA, they are meant for long-term investments and are subject to the ebbs and flows of the market.

529 plan contributions are typically made post-tax and are not tax-deductible at the federal level when you put the money in the account, though some states do offer tax deductions. That said, 529 plans provide tax-free withdrawals for qualifying educational expenditures. 529 plans do not have a fixed federal annual contribution cap like IRAs, but contributions are subject to gift tax rules and state plan limits.

However, using 529 funds for non-qualified expenses may trigger federal income taxes and a 10% penalty on the earnings portion, and state tax consequences may also apply.

Coverdell Education Savings Accounts

A Coverdell Education Savings Account (ESA) serves a similar purpose as a 529 plan by helping families save for qualifying educational expenses. However, a Coverdell ESA is only available to those who meet certain income limits. It also has contribution limits and can only be opened for a beneficiary under 18 years old or with special needs, as per the IRS. Funds must typically be used before the beneficiary reaches age 30, unless they have special needs.

Coverdell ESA contributions are not tax-deductible, but the designated beneficiary can receive tax-free distributions to pay qualified education expenses.

Health Savings Accounts

A health savings account, or HSA is a tax-advantaged plan for people who have high deductible health plans (HDHPs). Since individuals with these plans may have higher out-of-pocket costs, an HSA can help make health care more affordable. Contributions are made with pre-tax dollars and can then be applied tax-free to qualified medical expenses, meaning you are essentially getting those goods or services at a discount.

HSAs are not use-it-or-lose-it accounts. Funds roll over from year to year, and you may keep the money even if you change jobs.

Points worth noting:

•   If you use money from your HSA for non-qualifying expenses (say, you need cash for an urgent home repair), the withdrawal will be taxed and subject to a 20% penalty.

•   Once you turn 65, you may use funds in your HSA for non-qualifying expenses without penalty, but these withdrawals are still taxable.

Filing Taxes on Savings Accounts

You must report any amount of earned interest from your savings accounts on your tax return. If you earn $10 or more in interest during the year, your banking institution will issue an IRS Form 1099-INT, send it to the IRS, and provide you a copy to use when reporting your taxes.

The Takeaway

Most traditional savings accounts are taxed, meaning that the interest earned is taxable. If an account earns more than $10 in interest per year, you and the IRS will each receive a Form 1099-INT reporting that money. Certain tax-advantaged accounts, such as IRAs and ESAs, may or may not be taxable. Check the fine print on your account to know how to handle earned interest come tax season.

While the interest you earn may be taxed, don’t let that stop you from saving. It can still be an important way to help your money grow.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

FAQ

How much money can you have in your savings account without being taxed?

The interest earned on any amount of money in a savings account will be taxed on the interest it earns. The financial institution where the funds are held will send a Form 1099-INT to the account holder and the IRS annually to reflect earned interest of $10 or more.

How can I avoid paying taxes on my savings account?

You cannot avoid paying taxes on any earned interest for a standard savings account. All interest earnings must be accounted for. Earned interest of $10 or more per account is reported on a 1099-INT form and sent to the IRS.

How much tax do I pay on a savings account?

It depends on your tax bracket. Your earned interest will be taxed at your income tax rate for the year.

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