Is High-Yield Savings Account Interest Taxable?

Now is a good time to earn savings account interest. The Federal Reserve raised interest rates yet again — to a 15-year high. While high-interest rates might be bad news for mortgage loan shoppers, it's good news for saving account rates. That's because when interest rates are high, interest on savings accounts increases, and the popularity of high-yield savings accounts typically increases too. For example, a recently launched Apple savings account offers a 4.15% interest rate. But wait! There are some taxes involved with your savings account that you need to know about. 

High-Yield Savings vs. Regular Savings 

Before diving into an explanation of how interest income from your savings account is taxed, it’s good to know the difference between a regular savings account and a high-yield savings or high-interest savings account. The latter has a higher interest rate than regular or traditional savings accounts. Interest earned on both types of savings accounts is considered taxable income by the IRS. Also, interest earned from other types of accounts like money market accounts, certificates of deposit (CDs), and interest-bearing checking accounts is also generally considered taxable income.

But because you are earning more interest income from a high-yield savings account, the amount that is subject to tax is typically greater. However, you are also earning more money on your savings in what is usually an FDIC-insured account. So consider the pros and cons of having some of your money in a high-yield savings account.

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How Savings Account Interest is Taxed 

While you won’t owe taxes on the principal account balance in your savings account, any savings account interest earned is considered taxable income. The IRS taxes interest from high-yield savings accounts (and traditional interest-bearing savings accounts) at the same rate they tax other income (e.g., from your job). Any money you accumulate in interest is added to your other taxable income.

• The amount that you owe on interest income is based on your federal income tax bracket. So generally, the higher your income, the higher your tax bracket and the more tax you could owe on your interest income. 
• Your income tax bracket is tied to a federal tax rate that is based on your filing status and taxable income from all sources, including interest).

There is some good news, though. Since the IRS adjusts federal income tax brackets each year for inflation, you could pay a lower tax rate for 2023 than you paid last year.

So, for example, let’s say that you earn $10,000 in interest income and your marginal tax rate is 22% based on your 2023 federal income tax bracket. Using that information, the tax on your savings account interest would generally be $2,200. 

On the other hand, if you have $20,000 in your high-yield savings account and earn 3.75% interest, you would not be taxed on the $20,000, which is your savings account principal balance. Instead, you would only be taxed on the 3.75% you earned in interest.

Note: Some people might be subject to an additional tax called the Net Investment Income Tax (NIIT). NIIT is currently a 3.8% tax on capital gains, rental property income, and dividend income for filers with higher incomes.

Here are the federal marginal tax rates for 2023.

How Much Savings Account Interest Income is Taxable?

All of your high-yield savings account interest is taxable. Your financial institution will send you a Form 1099-INT once you earn more than $10 in interest. However, the IRS still requires that you report any savings interest earned, even if the amount you earn is under the ten-dollar threshold. You report savings account interest income on your tax return in the year it is earned. 

Note: You might also need to pay income tax on interest earned at the state level. Most states consider interest from high-yield savings accounts taxable. Even New Hampshire, which is a state with no income tax, has a special income tax for interest income. 

Have Savings Account Interest Rates Peaked? 

The Fed indicated that it might be done raising interest rates — at least for a while. So, that could mean that savings account interest rates may be at their peak. But if you’re interested in a high-yield savings account, don’t necessarily avoid it because of the taxable interest. 

There are several tax strategies from tax loss harvesting to holding savings in a 401(k) or IRA that can potentially minimize your overall tax burden so that you avoid paying taxes on savings account interest. 

• Consult a trusted professional tax professional or financial planner if you are unsure whether a high-yield savings account is the right move for you this year.
• Also, check out Kiplinger’s coverage of the best no-fee high-yield savings rates for 2023.