Understanding tax on savings account

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Tax on savings account

Most people don’t earn a ton of interest on their savings accounts. But that doesn’t stop the IRS from taking a slice of any interest you do earn – most of the time. Here’s what to know about interest tax on savings accounts. 

How is a savings account taxed?

When it comes to taxing bank accounts, you don’t owe the IRS anything on the deposits you make. However, you do have to pay taxes on any interest your saved dollars earn. Generally, you pay interest tax at your ordinary income tax rate. Here’s what those brackets look like for the 2021 tax year. 

Tax RateSingle Income BracketsMarried Filing Jointly Income BracketsHead of Household Income Brackets
10%$0 to $9,950$0 to $19,900$0 to $14,200
12%$9,951 to $40,525$19,901 to $81,050$14,201 to $54,200
22%$40,526 to $86,376$81,051 to $172,750$54,201 to $86,350
24%$86,377 to $164,925$172,751 to $329,850$86,351 to $164,900
32%$164,926 to $209,425$329,851 to $418,850$164,901 to $209,400
35%$209,426 to $523,600$418,851 to $628,300$209,401 to $523,600
37%$523,601+$628,301+$523,601+

How do I pay taxes for interest earned on a savings account?

If you earn more than $10 on your savings in a year, your financial institution is required to send you tax form 1099-INT. Your 1099-INT details how much you earned on which account(s). You’ll need this information when filing your income tax return. 

But even if you don’t receive a 1099-INT (which may happen if you receive under $10), you’re still on the hook for taxes on savings account earnings. Depending on your bank, they may provide that information in a handy document. Or you may have to go through your monthly statements to add up your annual interest earnings.  

How to avoid tax on savings account

Unfortunately, you can’t wiggle out of paying income taxes on regular savings accounts. However, there are ways to save that do come with tax advantages on earned interest. 

Tax-deferred accounts 

Tax-deferred accounts let you invest after-tax dollars to save for retirement. Any interest you earn in the account grows tax-free until you retire. Then, you’ll pay your ordinary income tax rate on withdrawals. 

Traditional 401(k)s are employer-sponsored accounts that often offer additional perks, such as employer matching. Individual retirement accounts (IRAs) also offer tax-deferred benefits, but you can open these accounts on your own. 

Tax-exempt accounts

You can also invest in a tax-exempt retirement account, such as a Roth IRA or Roth 401(k), to lower your interest tax bill. Unlike a tax-deferred account, you contribute to these accounts after you pay taxes. Then, the money grows tax-free until retirement, at which point you don’t have to pay taxes on withdrawals – or on interest earned. 

Flexible spending and health savings accounts

Flexible spending accounts (FSAs) and health savings accounts (HSAs) also offer interest tax savings. While FSAs must be set up by your employer, HSAs are only available to individuals with high-deductible health plans. 

Both types of accounts let you contribute pretax income up to a specified limit, depending on your income and family size. The money you put in may be invested or otherwise earn interest. As long as you use the funds on eligible medical or dental expenses, you won’t have to pay taxes on withdrawals. (But if you use the money for unrelated expenses, you’ll owe income taxes and a penalty tax.) 

Education oriented accounts

If you’re planning to invest in your or your child’s education, you may have additional ways to save on taxes on savings accounts. 

For instance, with a 529 savings plan, you can pay for K-12 tuition, college, or even make student loan payments. 

Coverdale Education Savings Accounts (ESAs) are another option, though they act more as a trust or custodial account. With an ESA, you may be able to cover additional education-related expenses for elementary and secondary schoolchildren.

Both of these accounts allow you to save after-tax dollars and enjoy tax-free growth and withdrawals. (Providing you use the money for qualified education expenses, of course.) However, these accounts generally don’t allow you to deduct your contributions, unlike retirement accounts. 

Invest in municipal bonds in your state

Another way to earn tax-free interest is to invest in municipal bonds. To encourage investment in local projects, interest earned on municipal bonds is federal, state, and local tax-free as long as you live within the state where the bond was issued. 

Permanent life insurance

Permanent life insurance is a policy that provides coverage throughout your life (as long as you pay your premiums). One perk of these policies is that any payout your beneficiaries receive is generally 100% tax-free. Additionally, permanent life insurance builds up cash value as you pay your premiums, which you may be able to borrow from tax-free. 

Is interest income taxable? Usually – but not always 

Whether you want to build a safety net for medical emergencies, go back to school, or prepare for retirement, you can build a tidy nest egg for many major goals. And while regular savings accounts generally earn taxable income, specially designated accounts may let you save tax on savings accounts.

FAQ

How much tax do you pay on a savings account?

You pay taxes on the interest earned in your savings account at your regular income tax bracket.

How can I avoid paying taxes on my savings account?

You can’t avoid paying taxes on interest earned in your regular savings accounts. But you can save in accounts meant to help you prepare for health emergencies, school, or retirement and earn tax-deferred or tax-free growth.

Is interest from savings account taxable?

Every dollar you earn in a regular savings account is taxable in your regular income tax bracket.

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