Saving money is important for people of all income levels. It can provide funds for emergencies, investments and retirement planning. As part of their financial planning, people should understand how their savings accounts are taxed and the implications for their tax liability.
This article will explain the rules and details of how savings accounts are taxed by examining interest, capital gains and dividend distributions, as well as special savings accounts available to help defer taxes.
What is a Savings Account?
A savings account is a financial account held at a bank, credit union or other financial institution that accepts deposits and earns interest. Savings accounts are typically used to help people save money to pay for expenses on a short-term basis.
The interest earned on savings accounts is usually calculated on a daily basis and paid out quarterly or annually. Interest rates usually vary between banks, so it’s important to shop around to get the best return. Banks may also impose limits on withdrawals and other fees, so ensure that you understand their terms and conditions before opening an account.
How Are Regular Savings Accounts Taxed?
Interest earned from a regular savings account is subject to taxation by the Internal Revenue Service (IRS) and is typically included on your federal tax return as interest income. The interest income is taxed at the same rate as your other sources of income, such as wages and investments.
It is important to note that you may be required to pay taxes on the interest earned even if you don’t receive a Form 1099-INT. Any amount of interest earned over $10 should be reported by the bank and accounted for on your federal income tax filing.
Savings accounts that hold money withdrawn from retirement accounts, such as a 401(k) or IRA, may be subject to additional taxes. Consult a qualified accountant or a tax professional for more information.
What about Capital Gains and Dividends?
Capital gains and dividend income from investments held in a savings account are subject to taxation. It is important to note that the rate of taxation on dividend and capital gains income may be different from the rate of taxation on interest income.
Capital gains from investments held in a savings account are typically taxed at the same rate as other capital gains. Long-term capital gains are generally taxed at lower rates than short-term gains.
Dividend income is typically taxed at the same rate as other sources of income such as wages. Because dividend distributions are usually not taxed until the dividend is actually paid out, savings account holders may be able to defer taxation on their dividend income by reinvesting the dividends, as opposed to cashing them out.
Savings Accounts to Help Defer Taxes
There are certain types of savings accounts available to help people defer capital gains taxes and avoid taxation on dividends and interest earned. Some of these accounts include:
• Traditional and Roth IRAs – These are tax-deferred or tax-free retirement accounts, respectively. They offer potential tax savings by allowing you to contribute post-tax money that earns and grows tax-free.
• Roth 401ks – These are similar to Roth IRAs but are employer-sponsored retirement plans. Contributions are made with after-tax money, so you don’t have to pay taxes on the money when you take it out.
• Health Savings Accounts (HSAs) – HSAs are a type of tax-advantaged savings account that can be used to pay for medical expenses. Contributions and earnings are tax-free when used for qualifying medical expenses.
• Brokerage accounts – These are accounts offered by brokerages and other financial institutions that allow you to invest in a variety of products, including stocks, bonds, mutual funds, and ETFs. Gains from investments in a brokerage account can be deferred and potentially avoided by reinvesting dividends and profits from capital gains.
Saving and investing for the future is an important part of building a secure financial future for yourself and your family. Understanding the rules for how savings accounts are taxed can help you to make informed decisions about where and how to save your money.
Keep in mind that the types and degree of taxes on savings accounts can vary, so it is always important to consult a qualified accountant or tax professional when making decisions about your savings.
By understanding how savings accounts are taxed, you can more effectively manage your money while still reaping the benefits of saving and investing.