Do I Have to Pay Taxes on My Savings Account? Know All About It Here

A few decades ago, nearly all savings accounts were used exclusively as safe storage for money and other valuables, such as jewelry and precious metals. However, the banking industry has witnessed tremendous advancements over the years. We now have numerous bank accounts serving different needs.

Bank accounts fall into various categories depending on several parameters. These include the target client, deposit and withdrawal limits, withdrawal frequency, and the number of account holders. Bank accounts may also vary depending on the taxes applicable.

If you’ve been considering opening a savings account, you’ve probably wondered if it will attract any taxes and how much. Well, this article shall delve into those concerns.

But first, let’s begin by understanding what a savings account is so you can open one from the point of information.

Introducing Savings Accounts

It’s impossible to discuss taxes on savings account without understanding what this account is all about.

A savings account is pretty much what the name suggests – a bank account at a retail bank opened primarily for saving money.

Savings accounts were once also known as passbook savings accounts. That’s because transactions on these accounts were traditionally recorded in a passbook, and there were no provisions for bank statements.

Besides offering a safe place to hold your money, savings accounts may double as a passive income-generating venture. That’s because most of these accounts pay interest. Nearly all savings accounts generate compound interest over a given duration.

Many countries require that savings accounts be protected by deposit insurance. Others provide some form of a government guarantee that insures a significant portion of the account balance.

Features of Savings Accounts

The one feature that applies to nearly all savings accounts is the limited number of withdrawals. That’s perfectly understandable, considering that most people open savings accounts for the purpose of holding their money for a more extended period.

The number of withdrawals you can make from your savings account depends on your bank. Some banks allow as few as a weekly withdrawal, while others offer more generous withdrawal terms.

Another feature of savings accounts, as already hinted, is the ability to earn interest. Banks compensate savings account holders with interest as an incentive for reduced liquidity (cash accessibility). However, it’s important to note that your bank isn’t paying you for being disciplined in not withdrawing from your savings account.

Instead, the institution trades with the money in your account to generate revenue. It then shares that revenue with you at a fixed interest rate.

Savings accounts also attract limited transfer options. Again, this is a measure to prevent the account holder from spending their savings unnecessarily.

The lack of overdrafts is another noteworthy feature of most savings accounts. Note that overdrafts are usually indicative of reckless spending habits. Exempting your account from this facility is one way your bank attempts to help you cultivate wise spending habits.

Last but not least, savings accounts lack check and linked debit card facilities.

Types of Savings Accounts

There are numerous types of savings accounts. Of notable mention are CD and HYSA accounts.  

A CD, short for a certificate of deposit, is a savings account that holds a fixed sum of money for a specified duration in exchange for interest. Account Holders can put their money in CD accounts for three months to five years or even longer. The longer the duration and amount fixed, the higher the interest rates. Interest rates in CD accounts are calculated per annum.

CDs attract higher interest than normal savings accounts. But the downside is that the fixed amount must remain untouched for the duration of the contract. Otherwise, you may lose any interests accrued besides incurring additional penalties.

HYSA (a high-yield savings account) is any savings account that typically pays higher interest rates on deposits than a regular savings account. Most CDs are high-yield savings accounts.

Other types of savings accounts include;

• Young savers account
• Retirees account
• Special investment account
• Christmas club account
• Money market account

Are Taxes Applicable on Savings Accounts?

It’s now evident that savings accounts can help you generate extra bucks on the side. Perhaps you’re now wondering, do I have to pay taxes on my savings account?

Savings accounts (in and of) themselves aren’t considered investments. That means the money held in these accounts doesn’t attract taxes. However, any interest earned from your savings account is subject to taxation.

The Internal Revenue Service (IRS) considers interests earned from savings accounts taxable. Regardless of whether you continue to hold the money in your account, reinvest it, withdraw it, or transfer it to another account. So, it’s important to note that you owe the IRS taxes as soon as your bank pays you interest on your savings account.

Why isn’t the whole amount taxed?

As indicated, the IRS won’t tax the money in your savings account. That’s because you presumably already paid taxes before banking the cash.

Let’s say you have $100,000 stashed away in a high-yield savings account, and the amount attracts a 5% interest after a given period. The taxable amount will be 5% of $100,000, which equals $500. It’s also worth noting that the IRS will not demand the entire $500. Instead, the agency will take a minimal cut based on the applicable taxes.

The law imposing taxes on all interest earned from financial accounts took effect on November 26, 1960. It applies to both financial accounts as well as bonds, promissory notes, and similar investment instruments.

Since all interests earned from savings accounts are subject to taxation, the law requires relevant account holders to report their taxable income to the IRS.

How Much Tax Will I Pay on My Savings Account?

As interest earned from savings accounts is taxable, it’s only fair to know the percentages of taxes applied. This information will help you make an informed decision on whether to go ahead and open a savings account or consider other investment channels.

The taxes imposed on savings account interests depend on the federal income tax bracket for the year.

The table below shows the federal income tax bracket for 2023, with the filing deadline being April 15, 2024;

NOTE: The percentages represent what the IRS taxes on your savings account based on the amount and the filing entity. They’re different from the actual interest rates charged on your savings.

It’s also worth noting that banks impose different interest rates on savings accounts. These rates can range from <1% to >5%, depending on your savings amount and the term of the contract.

Does Your Savings Account Balance Matter?

You now know that taxes on savings accounts apply only to the interests earned and not the sum saved or invested. However, the amount you invest in a savings account determines the interest earned.

More savings will attract higher interests and, consequently, higher taxes.

Investing more into a savings account is a win-win situation for both the account holder and the IRS. Although you’ll end up paying higher taxes, there’s the peace of mind of knowing that all the taxable income was earned on the side.

How Do You Know That You Owe The IRS?

Savings account interest is similar to any regular earnings. Therefore, you must report it to the IRS on Form 1099-INT.

Fortunately, most financial institutions with interest-earning accounts send their clients a 1099-INT form for any interests earned in their savings account. This only applies to taxable interest (interest over $10). However, the law still requires savings account holders to declare any interest earned to the IRS, even under $10. Failing to do so could attract severe penalties.

The 1099-INT is typically sent via email. However, your bank may fail to email the form to you. This usually happens when the interest is below $10 or if you did not submit a Social Security number while opening your bank account. Even then, you must still report any earnings and pay any owed taxes.

Without the 1099-INT form, the easiest way to file your returns is to look through your bank account statements and add up all interests earned during the tax period.

In case you did not provide a Social Security number or provided the wrong number, your account may be subject to backup withholding. This is an arrangement where your bank withholds 24% of all interests earned to pay any outstanding taxes.

How Can I Reduce Tax Obligations On My Savings Account?

Although savings account taxes generally apply to interests earned from these accounts, you can implement certain tips to minimize your tax obligations. One such method is by diversifying your money across tax-advantaged savings accounts.

Some tax-advantaged savings accounts include;

• Traditional IRA or 401 (k)
• Roth IRA or Roth 401 (k)
• Health savings account (HAS)
• 529 Education savings account

Summary

Savings accounts may attract taxes. But it’s reassuring to know that these taxes only apply to interest earned and not the account balance.

Besides, savings accounts offer many benefits over and above other account types like current and checking accounts.