Paying Taxes on CD Interest, Maturity, or Withdrawals

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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 both simple and safe. But taxes make everything more complicated. So, is there a tax on CD earnings, and if so, when do you have to pay? Perhaps more importantly, how can you avoid paying taxes on a CD?

CD Tax Overview

Interest earnings: In taxable accounts (like joint and individual accounts), you typically must pay income tax on the interest you earn from a CD. The IRS treats interest as interest income, and you generally report the income for the year in which you receive the income.

Maturity: When your CD matures and your bank transfers the proceeds to your savings or checking account, that’s usually (but not necessarily always) 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.

CD taxes aren't always straightforward. You might not be sure when you “received” interest earnings (or were entitled to receive interest), and other aspects might be unclear. Whenever you have questions about how to report something on your taxes correctly, speak to a local tax preparer or CPA who can provide guidance specific to your financial situation.

Form 1099-INT: You should receive a form 1099-INT if you earn more than $10 in interest. If you make less than $10, you still generally report the income to the IRS—even though you didn’t receive a tax form. Financial institutions must send Form 1099-INT by January 31st of each year.

Tax rate: There is no specific tax rate for interest earned on CDs. The rate you pay taxes at depends on everything else on your return, and your tax rate can change from year to year. The same is true for ordinary income you earn at your job.

Retirement Accounts

Traditional (pretax) accounts: If you hold a CD in a retirement account, like an IRA or SEP, you most likely do not owe income tax on the interest as you earn it every year. Instead, you generally face taxes later as a result of withdrawing funds from the retirement account.

When taking distributions from a pretax retirement account, you typically owe taxes on the entire amount you withdraw. That includes the original principal investment as well as interest earnings you receive.

Roth (after-tax) accounts: If you’re using a Roth IRA (or other Roth account with CDs), you might not ever have to pay income tax on the interest you earn. But it’s crucial to follow all IRS rules to qualify for tax-free income. Verify the details with your CPA.

Reporting: Your retirement account custodian should provide a Form 1099-R to assist with reporting any distributions from retirement accounts.

CD Penalties

When you buy a CD, you commit to leaving the money invested in the CD for a specific amount of time. But if you need money for an emergency, you can often pull the funds out early. Unfortunately, doing so will often cost you. Banks charge early withdrawal penalties, usually expressed as several months’ worth of interest.

It’s possible for early-withdrawal penalties to exceed the amount of interest you’ve earned from a CD.

Look for the amount of any penalties in Box 2 of the 1099-INT from your bank. In some cases, that penalty might be deductible. Still, it might be better to find an alternative source of funds. It doesn’t make sense to pay a dollar to your bank in penalties and receive a $0.30 tax break unless you’re out of options.

Reducing Taxes

If you’re concerned about your tax bill, meet with a Certified Financial Planner and tax advisor, who can give you specific advice. It might be possible to manage the types of income 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 receiving more tax-friendly earnings in your taxable accounts?

Important: Tax laws are complicated, and they change frequently. This page only provides a general overview, and cannot be used to complete your tax forms or avoid tax penalties. This information is provided without any knowledge of your individual circumstances, so you cannot rely on it for specific advice. Speak with a properly-licensed professional who can give you specific guidance after reviewing your finances.