Did You Get a High-Yield Savings Account? Watch Out for This One Big Surprise at Tax Time

Did you open a high-yield savings account recently? Earning more interest on your savings is good news — except at tax season. You should have received a 1099-INT tax form for your savings account, which banks use to report interest income. The money you earned on your savings is taxable interest.

See what your high-yield savings account could mean for your taxes in 2024 — and how to make some tax-planning moves for the future.

This challenge is not unique to savings accounts — any kind of interest-earning account could result in taxable interest income. If you’ve opened a CD, if you have a high-yield checking account or money market account, or if you keep cash in your brokerage account, you could have interest income for the past year (or “ordinary dividends” for some types of accounts).

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But unlike your paychecks, where you can use W-4 withholdings to have taxes automatically taken out and sent to the government each month, interest income doesn’t have automatic withholdings. This can cause a surprise tax bill when you crunch the numbers for your April 15 tax-filing deadlines.

Who pays the most tax for high-yield savings account interest?

What is the tax rate on high-yield savings account interest? It depends on your tax bracket. Interest income is taxed as “ordinary income” (like income from a job) at your marginal tax rate. So people in higher tax brackets will have to pay a higher tax rate on their savings account interest.

For example, let’s say you’re in the 12% tax bracket (2023 taxable income of less than $44,725 for single filers, or less than $89,450 for married filing jointly). You have a high-yield savings account with a balance of $5,000 that earned 5% APY in 2023, for total interest income of $250.

Someone in the 12% tax bracket would owe about $30 on that interest income. This would reduce your refund by $30 — or you might owe an extra $30. Hopefully that $30 is not an excessive burden; it’s still worth getting the $220 of interest that you earned, right?

But for higher-income taxpayers, savings account interest becomes less of a good deal. If you’re in the 32% tax bracket, and you have $50,000 of savings that earned 5% APY in 2023, that means you have taxable interest income of $2,500. And you’ll owe $800 of tax.

How to avoid tax on savings account interest

I personally don’t mind paying tax on savings account interest, because it’s the price of freedom — savings accounts are flexible, liquid assets that let you withdraw your cash anytime for any reason. But if you’re feeling burdened by a high tax rate on savings account interest, you might consider a few options:

Put more money into your 401(k), traditional IRA, or HSA

Savings accounts accrue taxable interest, but not all accounts do. If you haven’t already, consider maxing out your 401(k). Or put more money into a tax-deductible traditional IRA or health savings account (HSA) if you qualify. Putting more money into tax-deductible accounts could help offset the extra interest income from your savings account, and get you a bigger tax refund.

You could also put extra cash into a Roth IRA. It won’t give you a tax deduction, but your investments can grow tax free, without any 1099-INT statements. Roth IRAs (like 401(k)s, traditional IRAs, and even HSAs) can put your money to work with investments, without causing you to owe more taxes on this year’s return.

Buy more stocks or other investments that earn capital gains

If you don’t qualify for, don’t want to use, or don’t want to max out any other tax-advantaged accounts, you could also consider using a brokerage account to avoid taxable interest income. Instead of keeping cash in a savings account, you can buy stocks, bonds, or ETFs. You won’t owe taxes until you sell the investments (you still pay taxes on dividend income) — and if you wait more than a year to sell, you’ll owe long-term capital gains tax, which often has a lower rate than many tax brackets.

Note of caution: These money moves should only be made for “extra” cash that you want to invest more aggressively for long-term goals. If your high-yield savings account is also your emergency savings fund, you should leave that money in your bank account and just keep paying taxes on it. Don’t put your emergency savings into stocks or other risky assets; don’t lock up your emergency savings in a 401(k) or IRA where it’s hard to withdraw your money.

Bottom line

High-yield savings accounts are a great way to keep your cash safe while also earning a good yield. But these interest-earning accounts can also lead to taxable interest income that could shrink your tax refund. It’s good to be aware of how much interest your savings account earned last year, and how much tax you might owe because of it.

But don’t make any big, risky investment moves with your emergency savings. Some higher-income people might want to reconsider their cash holdings for tax purposes. But unless you have lots of money in the bank, you’re probably better off leaving your savings in a high-yield savings account — some taxes are well worth paying.

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