What Are Dividends in Savings Accounts?
Unpack the true nature of "dividends" in savings accounts, distinguishing them from other financial distributions and explaining their financial implications.
The term “dividends” often causes confusion when discussing savings accounts, as it’s commonly linked to stock market earnings. However, for certain financial institutions, especially credit unions, “dividends” refer to earnings paid on savings accounts. This article clarifies what dividends mean in the context of savings accounts and how they function.
Dividends in Savings Accounts Defined
“Dividends” paid on savings accounts are essentially interest payments, though the terminology differs based on the type of financial institution. Credit unions, unlike traditional banks, are member-owned, not-for-profit financial cooperatives. Their earnings are returned to members rather than external shareholders. Consequently, the payments members receive on their deposits are termed “dividends” because they represent a share in the credit union’s profits, distributed back to its member-owners.
This contrasts with traditional banks, which are for-profit entities that pay “interest” to their customers and distribute profits to shareholders. While both dividends and interest serve as compensation for deposited funds, the underlying structure of the institution dictates the term used.
How Dividends are Earned and Distributed
The process of earning and distributing dividends on savings accounts at credit unions operates similarly to how interest is earned at banks. These earnings are calculated using a “dividend rate,” analogous to an annual percentage yield (APY), which reflects the annual return on deposits. Many credit unions compound dividends daily, crediting earnings to accounts monthly.
The actual amount of dividends earned can be influenced by factors such as the account’s average daily balance or minimum balance requirements. For example, some accounts may require a minimum balance, such as $5 or $100, to qualify for dividend payments. Dividends begin to accrue on the business day non-cash deposits, like checks, are placed into the account. The specific dividend period, compounding frequency, and crediting schedule are determined by the credit union and outlined in the account’s terms.
Taxation of Savings Account Dividends
For tax purposes, dividends received from credit union savings accounts are treated as interest income. They are taxed at ordinary income rates, just like interest earned from traditional bank accounts. These are not considered qualified dividends, which are a specific type of corporate dividend that may be eligible for lower capital gains tax rates. The Internal Revenue Service (IRS) classifies these payments as interest income under Section 61 of the Internal Revenue Code.
Credit unions are required to issue Form 1099-INT to account holders if total dividends earned during the year are $10 or more. This form reports the interest income to both the account holder and the IRS. Even if the amount earned is less than $10 and a Form 1099-INT is not received, taxpayers are still responsible for reporting this income on their tax return. For taxable interest income exceeding $1,500, it must be reported on Schedule B (Form 1040). Smaller amounts can be reported directly on Form 1040.