For years, savings accounts have paid an abysmal interest rate. But in recent months, we’ve seen accounts paying significantly more: currently, the range for high-yield online savings accounts is between around 1.6% and 2.15%, compared to well under 1% the 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 on 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 by keeping your money there,” says Alana Benson, investment spokesperson for NerdWallet. 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 taxes than the interest you earn,” says Jim Evans, Certified Financial Planner, co-founder and vice president of TTG Financial.
Plus, higher rates on your savings account are great news, even if there’s a tax bill associated with it. “We could even say that any rate on your savings is good news, because many banks have been paying virtually no interest on savings for the past few years,” says Evans. (See the highest rates you can get on a savings account here.)
As for how much your interest income will cost you, that depends on your marginal tax rate. If you already pay taxes on your other income, the interest you earn on your savings will be taxed at your top 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 hike,” Benson says.
A couple earning $150,000 with a top marginal rate of 22% who split $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%, it will increase their tax bill by [roughly] $121 to $132, but their income was more than their tax bill, so overall that’s good news,” Evans says.
How will you know if you owe the IRS for 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,” Benson says. And that’s something you’ll need to include on your tax return.
But if you receive 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 may mean a higher tax bill. In recent years, this has not generated a lot of income for most people because savings account interest rates have been very low, but for a $100,000 account that would mean an additional $2,000 income, which for a single one someone with a taxable income of $90,000 would add an additional $480 to their tax bill,” says Certified Financial Planner Jud Mallini of Together Planning.
Any advice, recommendations, or rankings expressed in this article are those of MarketWatch Picks, and have not been reviewed or endorsed by our business partners.