How Much Tax Do You Pay on Your Savings?

When you earn money from your savings, it is considered income and may be taxed. Different types of savings and investment vehicles have distinct tax treatments. The way your savings are taxed depends on the nature of the income generated, such as interest, dividends, or capital gains, and whether the savings are held in a standard account or a specialized tax-advantaged account. Navigating these rules helps individuals manage their financial obligations accurately.

Taxation of Interest and Dividends

Interest income from various savings vehicles is taxed as ordinary income. This includes earnings from traditional savings accounts, checking accounts, money market accounts, Certificates of Deposit (CDs), and corporate bonds. This income is added to your other taxable income and taxed at your marginal income tax rate, which can range from 10% to 37% for the 2024 tax year, depending on your total income and filing status.

Dividends received from stocks and mutual funds are taxed differently based on their classification. Non-qualified, or ordinary, dividends are taxed at your regular ordinary income tax rate, similar to interest income. These might include dividends from real estate investment trusts (REITs) or money market funds.

Qualified dividends receive a more favorable tax treatment, taxed at the lower long-term capital gains rates. To be considered qualified, dividends must be paid by a U.S. corporation or a qualified foreign corporation, and the stock must be held for a specific period. For 2024, the tax rates for qualified dividends are 0%, 15%, or 20%, depending on your taxable income bracket. For example, a single filer with taxable income up to $47,025 in 2024 would pay 0% on qualified dividends.

Taxation of Capital Gains

A capital gain arises when you sell an asset, such as stocks, bonds, mutual funds, or real estate, for more than its purchase price, known as your basis. This basis typically includes the original cost plus any acquisition fees. The profit from this sale is subject to capital gains tax, and the rate depends on how long you held the asset before selling it.

Short-term capital gains occur when you sell an asset that you have held for one year or less. These gains are taxed at your ordinary income tax rate, meaning they are added to your regular income and taxed at the same marginal rates that apply to wages or interest income.

Long-term capital gains apply to assets held for more than one year before being sold. These gains benefit from preferential tax rates, which are typically lower than ordinary income tax rates. For the 2024 tax year, the long-term capital gains tax rates are 0%, 15%, or 20%, depending on your taxable income level. For instance, a married couple filing jointly with taxable income up to $94,050 in 2024 would pay 0% on their long-term capital gains.

How Tax-Advantaged Accounts Work

Tax-advantaged savings accounts offer specific benefits that can reduce or defer your tax liability on earnings. These accounts are structured to encourage saving for particular goals like retirement or education. The tax benefits usually involve contributions, the growth of investments within the account, or withdrawals.

Traditional Individual Retirement Arrangements (IRAs) and 401(k) plans allow for tax-deductible contributions. Investments within these accounts grow tax-deferred. Taxes are generally paid when you withdraw funds in retirement, at your ordinary income tax rate at that time.

Roth IRAs and Roth 401(k)s operate differently, with contributions made using after-tax dollars. Qualified withdrawals in retirement are entirely tax-free, including all earnings. This means that interest, dividends, and capital gains that accumulate within the account are never taxed, provided the withdrawal meets specific requirements.

Health Savings Accounts (HSAs) offer a triple tax advantage when paired with a high-deductible health plan. Contributions are tax-deductible, investments grow tax-free, and qualified withdrawals for eligible medical expenses are also tax-free.

529 plans are designed for saving for qualified education expenses. Contributions are not tax-deductible at the federal level, but many states offer state income tax deductions or credits for contributions. The earnings within a 529 plan grow tax-free, and qualified withdrawals for higher education expenses are also tax-free.

Receiving and Understanding Your Tax Forms

When you earn income from your savings, financial institutions are generally required to report these earnings to you and the Internal Revenue Service (IRS) on specific tax forms. Understanding these forms is important for accurately preparing your tax return. These forms summarize the types and amounts of income you received during the calendar year.

Form 1099-INT reports interest income paid to you by banks, brokerage firms, and other financial institutions. This form shows the total interest earned from savings accounts, checking accounts, money market accounts, Certificates of Deposit, and bonds.

Form 1099-DIV reports dividends and other distributions of $10 or more from stocks and mutual funds. This form differentiates between ordinary dividends and qualified dividends, which are taxed at different rates. It also reports any capital gain distributions from mutual funds.

Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” is issued by brokerage firms to report the proceeds from the sale of stocks, bonds, mutual funds, and other securities. While it reports the proceeds, it does not include the cost basis of the sold assets, which is necessary to calculate your capital gain or loss.

Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,” reports distributions from retirement accounts like IRAs and 401(k)s. This form indicates the total amount distributed and whether any portion of the distribution is taxable. It is essential for understanding the tax implications of withdrawals from your tax-advantaged retirement savings.