Do You Get Taxed on Savings Accounts?

Many people save money in bank accounts for various financial goals, from emergency funds to future purchases. A common question arises regarding the tax implications of these savings. While the money you deposit, known as the principal, is not taxed again, the interest earned on that principal is generally considered taxable income.

Taxation of Savings Account Interest

Interest income generated from traditional savings accounts, money market accounts, and Certificates of Deposit (CDs) is subject to federal income tax. This income is taxed at your ordinary income tax rate, which is the same rate applied to wages or salaries. For instance, if you earn $100 in interest, that amount is added to your total taxable income for the year.

The principal amount you deposit into a savings account is not taxed because it has already been taxed as income or was otherwise acquired in a non-taxable manner. Only the additional money generated by the account through interest is subject to taxation. Interest becomes taxable when it is credited to your account, even if you do not withdraw the funds.

Reporting Your Savings Account Income

Financial institutions issue Form 1099-INT (Interest Income) to account holders who earn $10 or more in interest during a calendar year. You should receive this form by January 31st of the year following the one in which the interest was earned. Box 1 on Form 1099-INT shows the total taxable interest you received from that particular institution.

Even if you earn less than $10 in interest and do not receive a Form 1099-INT, you are still required to report all interest income on your tax return. This income is reported on Form 1040, U.S. Individual Income Tax Return. If your total taxable interest from all sources exceeds $1,500, you will also need to complete and attach Schedule B (Form 1040), Interest and Ordinary Dividends, to your tax return.

Tax-Advantaged Savings Alternatives

Several savings vehicles offer different tax treatments compared to standard taxable savings accounts, allowing for potential tax benefits. Individual Retirement Accounts (IRAs), such as Traditional and Roth IRAs, provide tax advantages for retirement savings. Traditional IRA contributions are tax-deductible, and earnings grow tax-deferred until withdrawal in retirement, at which point they are taxed. Roth IRA contributions are made with after-tax dollars, but qualified withdrawals in retirement, including earnings, are tax-free.

Health Savings Accounts (HSAs) offer a triple tax advantage: contributions are tax-deductible, earnings grow tax-free, and qualified withdrawals for medical expenses are also tax-free. These accounts are available to individuals enrolled in a high-deductible health plan. Another option for specific goals is the 529 college savings plan. Contributions to a 529 plan are made with after-tax dollars, but earnings grow tax-free, and withdrawals are tax-free when used for qualified education expenses, which can include tuition for K-12 and higher education.