Interest rates were volatile in 2023, and anyone who has credit card debt or took out a loan recently has felt the pinch in their wallet. But there has also been a silver lining: As interest rates have climbed, banks have started offering higher interest on savings vehicles.

If you jumped at the chance to earn more in savings this past year, you’ll want to keep as much of the extra cash as you can. And that means knowing what the federal government’s share is and planning for it, since interest earned on savings accounts is taxable.

What You Have to Pay Taxes on

Earning more on savings accounts is a welcome change. Not so welcome: The Internal Revenue Service (IRS) requires a cut of that high-yield savings account interest. In fact, it gets a percentage of all your savings interest, including that paid on certificates of deposit (CDs).

The bad news is that the interest is taxed along with your other, ordinary income according to the tax bracket you fall into this year. (Brackets are updated annually to keep pace with inflation.) And those rates can be far less kind than the capital gains tax rate for stocks and real estate.

“When we’re in a good market, with high returns and interest rates, that income is taxable,” says , an accountant in Provincetown, Massachusetts. “For small investors, the amount is usually not significant. However, with the return of high-yield savings accounts and good market returns, some people may be in for a shock.”

Here’s an example: Let’s say you’re a single taxpayer with ordinary income of $100,000 in tax year 2023. You would be required to pay an ordinary income tax rate of 24% on the amount over $95,375 if $4,625 of that $100,000 derived from interest earned on money you plunked into a savings account. That works out to $1,110 that the IRS will want of your $4,625 gain.

Compare this to the 0%, 15%, or 20% rates payable on most capital gains. It’s something to keep in mind as you determine your savings strategy, because various types of savings vehicles are taxed differently.

Savings Account Interest and Earnings

Taxable interest, according to the IRS, is interest earned on money in an account that you can withdraw from without penalty. This includes savings accounts and distributions in the form of dividends, as well as savings bond interest.

Interest is usually taxable in the year when it becomes available to you, with a couple of exceptions. Interest earned on Series EE or Series I savings bonds, for example, isn’t taxable until they mature or you redeem them.

Money Market Accounts

A money market account is another type of popular, interest-earning savings vehicle. It is an interest-bearing account at a bank or a credit union account, typically with a higher interest rate than a regular savings account. Money market accounts may include check-writing and debit card options, but also usage restrictions that may vary based on the institution.

Overall, they are more of an investment than a traditional savings account that you can dip into whenever you want or need to without penalty. This earned interest is also taxed as ordinary income.

Treasury Bill Earnings

Treasury bills, or T-bills, are a type of time deposit. You commit your savings dollars for a period of time that can be as short as one month or as long as a year. You buy the bill, then the Treasury purchases it back again at the end of your term, referred to as its maturity date. The difference between what you paid and what you receive at maturity is the interest payment. 

Treasury bill interest is also taxed at ordinary income rates, but these investments aren’t subject to state taxes, so you can at least dodge that bullet. The interest is taxed in the year when the bill matures.

Certificates of Deposit (CDs)

A certificate of deposit (CD) is effectively a savings account that comes with an agreement that you won’t take any withdrawals for an agreed-upon and contracted period of time. The period can be anywhere from one month to five years or even longer. You’ll pay a penalty to the bank or credit union if you do take a withdrawal during this time.

You purchase the CD for a fixed deposit amount, so in most cases, you would not make additional deposits over that time. You’ll receive your deposit back plus interest at the end of the term. The interest rate is typically superior to that of a traditional savings account. It averaged 1.36% for a 12-month CD in February 2023, when traditional savings accounts were paying an average of 0.35%.

The IRS treats this interest earned as ordinary income as well, so it’s taxed according to your marginal tax bracket rate. Here’s the downside: You could pay tax on this interest income before you can withdraw any of it or your original deposit without penalty.

High-Yield Savings Accounts

These savings accounts are distinguished from traditional savings accounts in that they pay a more generous interest rate. They can be a sweet deal because you’re generally not limited as to when or how you access the money you’ve saved.

The downside is that you’re not guaranteed that higher interest rate throughout the entire time period that you hold the account. The rate can fluctuate, going up and down as influenced by the economy and, yes, the Federal Reserve. But even if the rate plummets, the interest would most likely be more than you would earn on a traditional savings account because those traditional rates would drop, too. However, other investment options could earn more.

Preparing for Tax Season

“I recommend that folks monitor their accounts on a quarterly basis and consider either making quarterly payments in anticipation of the taxes that they may owe, or think about investing in an IRA (individual retirement account), which would reduce their taxable income, if they’re noticing significant increases,” Capelli says. “The good news is that you can make a deposit in an IRA for the current year until April 15 (or whatever the tax filing deadline is) of the following year.” So you have until April 15, 2024, to make any last-minute adjustments.

In any event, the amount of interest you received during the tax year shouldn’t come as a big surprise on tax day. You should receive a Form 1099-INT from your bank or credit union early in the year if your account earned $10 or more.

It will tell you—and the IRS—how much interest you earned. This gives you a period of time to dispute the amount with your bank or credit union if it doesn’t seem right, or to at least ask for clarification. Your bank or credit union can then file an amended form. This is the amount that you’re obligated to report as interest on your tax return so it can be included in your total income.

You’ll receive a Form 1099-INT from the federal government as well if you’ve invested your money in Treasury bills. You can elect to have taxes withheld from these earnings. The amount that you’ve paid into the IRS through withholding will appear on the form in the box labeled “Federal Income Tax Withheld.”

You should also be prepared to deal with the net investment income tax (NIIT) in addition to your regular income tax bill if you’ve saved a significant amount of money and you’re a high-income earner. This “extra” tax has been in place since 2013 and applies to “interest, dividends, capital gains, rental and royalty income, and non-qualified annuities,” according to the IRS. The NIIT rate is 3.8%, and it’s levied on either your investment income or the amount by which your overall modified adjusted gross income (MAGI) exceeds certain limits, whichever is less.

For the 2023 tax year, these income limits are:

• $250,000 (married filing jointly, or qualifying widow or widower with a child)
• $200,000 (single or head of household)
• $125,000 (married filing a separate return)

Reducing the Amount You Owe

You have other savings and investment options if you’re concerned with that extra tax bill that might come due simply because you popped your spare money into a high-interest savings account.

You might want to look into tax-free or tax-deferred savings methods instead, such as Series EE and Series I bonds on which you won’t pay taxes on interest until you redeem them or they mature. And interest earned on state bonds and municipal bonds that raise money to fund government operations isn’t taxable at the federal level at all, although it may be taxable at the state level.

This tax provision varies from state to state, although you typically won’t pay tax to the state, county, or municipality that issued the bond.

Are High-Yield Savings Accounts Still Worth It?

Yes, the tax man cometh, but the bite shouldn’t be horribly painful if you prepare.

High-yield savings accounts are safe, and this can be an especially important factor if you’re retired or nearing retirement. They’re FDIC-insured for $250,000 per depositor, per FDIC-insured bank, for each account ownership category. That means your money is safe even if your bank goes toes-up, as happened five times in the United States in 2023. Plus, your money isn’t locked up and inaccessible under penalty for withdrawals, making it a good place for an emergency cash fund.

The Bottom Line

Where you save your money depends a great deal on what you want to do with it and when. Do you have a long-term window, such as saving for retirement or funding your child’s college education, or are you saving for a wedding within the tax year? There’s not much argument that a high-yield savings account is a better option than a garden-variety traditional savings account, but other types of investment and savings options might be more beneficial for you.

Consider talking to an accountant so you have a firm grasp of what your decision will cost you tax-wise, and perhaps a financial advisor as well to explore other options.