For years now, savings accounts have been paying abysmal interest. But in recent months, we’ve seen accounts pay much more: Currently, the range for high-yield online savings accounts is between about 1.6% and 2.15%, compared to well under 1% last year. (See the highest rates you can get on a savings account here.)
That said, there’s one thing to remember here: “The interest you earn from a high-yield savings account is generally taxable. You won’t be taxed on your contributions to your savings account, only on the interest you earn from keeping your money there,” says Alana Benson, NerdWallet investment representative. So while you may have earned very little from your savings last year, for some of you, this year will be a different story. But don’t worry too much: “You’ll never pay more in taxes than the interest you earn,” says certified financial planner Jim Evans, co-founder and vice president of TTG Financial.
Plus, higher interest rates on your savings account are great news, even if there’s a tax bill associated with them. “You could say any rate of interest on your savings is good news, as many banks have been paying virtually zero interest on savings in recent years,” says Evans. (See the highest rates you can get on a savings account here.)
As for how much interest income will cost you, it depends on your marginal tax rate. If you already pay tax on your other income, the interest you earn on your savings will be taxed at your highest marginal rate. “If you’re in the 22% tax bracket, you’ll pay 22% on your interest. Despite the tax burden, the benefit of receiving interest usually outweighs the small tax hit,” says Benson.
A couple earning $150,000 with a cap rate of 22% who splits $50,000 between a money market and a savings account can expect to earn about $550 to $600 in interest on their savings. “At 22%, this will increase their taxes by [roughly] $121 to $132, but their earnings exceeded their tax bill, so overall it’s good news,” says Evans.
How will you know if you owe the IRS on your savings account?
“Your bank may send you a 1099-INT tax form if you earned more than $10 in interest during the tax year,” says Benson. And that’s something you should include on your tax return.
But if you get a 1099-INT from the IRS in January, don’t worry. “As banks offer higher interest rates to their customers who have savings accounts or money market accounts, this can mean a higher tax bill. In recent years, this hasn’t added much income for most people, as interest rates on savings accounts have been very low, but for a $100,000 account, that would mean an extra $2,000 in income, which for a single person with a taxable income of $90,000 $ will add an additional $480 to his tax bill,” says certified financial planner Jud Mallini at Together Planning.
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