(Bloomberg) -- Savers who took advantage of the high interest rates being offered by high-yield savings accounts and certificates of deposit last year are waking up to a larger tax bill from Uncle Sam.
With US taxes due April 15, many taxpayers are facing a higher income-tax liability from the interest they earned through these accounts, potentially reducing their tax refund or even pushing them into a higher tax bracket.
“Taxpayers are aware they’re making money on those accounts, but the reality really hits you hard when you look at your consolidated 1099 brokerage statements or get your 1099-INT tax forms from banks and other financial institutions and see just how large the amount is,” said Miklos Ringbauer, founder of accounting and tax strategy firm MiklosCPA.
When the Congressional Budget Office last updated its projections, it forecast that taxpayers would report $282 billion of taxable interest and dividend income in the 2023 tax year, up from $237 billion in 2019, the last year for which the actual total is available.
For years, the rates on savings accounts had been near zero. But after the Federal Reserve began raising the benchmark federal funds rate in 2022, many financial institutions raised the yields offered on cash and cash-like investments, providing savers a way to earn a decent yield while staying liquid.
A big beneficiary of the shift has been Goldman Sachs Group Inc.’s Marcus high-yield online savings account, which is currently offering a 4.5% annual percentage yield. The average rate on a high-yield savings account was 4.33% in 2023, 1.09% in 2022 and just 0.38% in 2021, according to data from Bankrate.
“High-yield savings accounts have been a safe way to earn a nice return, but it is also the most ‘costly’ from a tax perspective,” said Alvina Lo, chief wealth strategist at Wilmington Trust. “Interest is taxed as ordinary income, which is a higher rate than gains from other types of investments that may be taxed at long-term capital gains rates.”
For instance, a single filer who earned $5,000 in interest in 2023, would owe about $1,600 in federal taxes, if he or she is in the 32% income tax bracket. By comparison, that same person would likely pay a 15% long-term capital gains tax of $750 if they had a $5,000 gain on a stock owned for more than one year.
For CDs, any interest earned is taxable annually, even if the CD doesn’t mature for a number of years. But where investors won’t have to pay tax on interest is if the CDs or other interest-earning investments is held in a tax-deferred retirement account like an IRA. Tax in those accounts comes due when money is eventually withdrawn.
To contact the author of this story:
Suzanne Woolley in New York at [email protected]