Do I Pay Tax on CD Interest?

Tax increase
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Certificates of deposit (CDs) are among the safest investments available. When covered by FDIC insurance (or NCUSIF in a federally insured credit union) they’re simple and safe. But taxes make everything more complicated - is there a tax on CD earnings, and when do you have to pay? More importantly, how can you avoid paying taxes?

CD Tax Overview

In most cases, you have to pay income tax on the interest you earn from a CD.

The interest is treated as interest income, and you’ll generally have to report the income for the year in which the income was received. When your CD matures and your money is returned to your savings account, that’s usually (but not necessarily) a return of your principal, which is not a taxable event.

For most people, things are simple: if your bank sends you a 1099-INT form at the end of the year, use that information and expect to pay tax on your CD earnings.

But things aren’t always simple. You might not be sure when your interest was “received,” and other things might be unclear. If you have any questions about how to report something on your taxes, speak to a local tax preparer who can look at your specific situation.

There is no specific tax rate for interest earned on CDs. The rate you pay at will depend on everything else on your return, and it could change from year to year – the same is true for ordinary income you earn at your job.

Retirement Accounts

If your CD is held in a retirement account such as an IRA, you most likely do not owe income tax on the interest as you earn it every year. Instead, you’ll pay the taxes when you withdraw funds from the retirement account. If you’re using a Roth IRA (or other Roth account), you might not ever have to pay income tax on the interest you earn.

CD Penalties

When you buy a CD, you commit to leaving the money in the CD for a certain amount of time. If something comes up, you can often pull the funds out early – but it’ll cost you. Banks charge early withdrawal penalties, usually expressed as several months’ worth of interest. Look for the actual amount of your penalty in Box 2 of the 1099-INT from your bank.

In some cases, that penalty might be deductible. But it’s always better to find an alternative source of funds – paying a dollar to the bank and getting a $0.30 tax break isn’t sustainable.

Reducing Taxes

If you’re concerned about your tax bill, meet with a local financial planner and tax advisor, who can give you specific advice. It might be possible to manage the types of income that you earn in different types of accounts. For example, if you’re paying high rates on CD interest, is there a way to earn interest in a tax-deferred (or tax-free) account, while getting more favorable earnings in your taxable accounts?

Important

Tax laws are complicated, and they change from time to time. This page only provides a general overview, and cannot be used to complete your tax forms or avoid tax penalties. Speak with a local professional who can give you specific advice after getting familiar with your finances.