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With high inflation, a volatile stock market and the closure of two major banks, many Americans are looking for safe places to get their money – like certificates of deposit (CD).
Not only do CDs offer a guaranteed rate of return, but thanks to rising interest rates, they also come with greater earning power than many other investment vehicles. Currently, some CD accounts offer APY of 4% or more. Your typical bank savings account only offers a rate of 0.37%.
However, these revenues are not free. If you are consider investing in CDshere’s what you need to know about how they’re taxed.
Check Out Today’s CD Interest Rates Here to see how much you could earn.
Do you pay taxes on CD earnings?
The IRS generally considers CD earnings as a type of income. This subjects them to typical federal and state income taxes, all other income is.
“The interest rate a CD earns you is called a yield,” says Marc Barnes, registered agent and managing partner at Copper Canyon Tax and Financial Services in Tuscon, Arizona. “The return earned on a CD is considered taxable on state and federal income tax returns. This is true regardless of how the money is paid out to the investor – whether it is physically received or reinvested.”
How much tax should you expect to pay for CD earnings?
The total you’ll pay in taxes on your CD earnings depends on two factors: the amount of interest earned on your CDs and the tax bracket you fall into.
For the first, see Form 1099-INT, which your bank or credit institution must send to you by January 31. It details your total interest income from the previous year.
Your tax bracket, on the other hand, depends on the total amount of taxable income you bring in each year (including your CD interest).
“Federal tax brackets for 2022 and 2023 range from 10% to 37% depending on a taxpayer’s filing status and taxable income,” says Robbin E. Caruso, partner and co-head of Prager Metis’ National Tax Controversy Practice in Cranbury, New Jersey.
How to Reduce the Amount You Pay in Taxes for CD Income
One way to reduce the taxes you pay — on CD Earnings or otherwise – is to live somewhere with no income tax, like Texas or Washington.
You can also use certain types of retirement accounts to buy CDs. Traditional IRAs, for example, aren’t taxable until you withdraw the money in retirement. (Remember that you could pay even more taxes if you then fall into a higher tax bracket).
Finally, you can also turn to other types of investments.
“For people living in high-income states such as California or New York, it may be interesting to compare CD yields to government-backed Treasury and Treasury bill yields,” says Michael Ashley Schulman, partner and Chief Investment Officer at Running Point. Capital Advisors in El Segundo, CA. “Income earned on them is not subject to state taxes.”
If you think a CD is right for you, check today’s CD interest rates online now.
The bottom line is
At the end of the day, everyone’s tax situation is different. If you want to avoid additional tax burden – or simply increase your tax refund – it is always best to consult a tax professional when planning and filing your tax returns. They can also help you better estimate (and prepare for) the taxes your CDs and other investments may require.