Are CDs taxable?

Certificates of deposit (CDs) are a great way to earn a yield and have your funds protected by federal deposit insurance. But are CDs taxable?

In short, yes. Unless the CDs are in a tax-advantaged account (such as a retirement or college savings account), the interest you earn on them counts as income and you’ll likely need to pay income taxes.

Are CDs taxable?

Generally speaking, earned interest is taxable.

“The Internal Revenue Service classifies interest earned from a CD as regular income, therefore making it subject to taxation,” said Bruce McClary, senior vice president at the ​​National Foundation for Credit Counseling. 

By January 31 each year, you should receive Form 1099-DIV from any credit union CD provider and Form 1099-INT from any non-credit union CD provider where you invested, reporting the amount of interest you earned in the previous calendar year. 

How CDs are taxed

If your CD is not in a tax-advantaged savings account, you’ll pay taxes on the yield it earns each year. This applies even if the CD is long term, lasting multiple years.

You’ll need to pay taxes whether or not you take interest payments during the CD’s term and no matter the CD type — traditional, no-penalty, jumbo, brokered, etc.

Yet, only the interest you earn is taxable — you’re not taxed on the CD’s principal or the entire CD. This is because the funds you invested in the CD (most likely) were already subject to income tax — you’re not double-income taxed on the same money. 

How much you’ll pay is unique for each person, depending on your income tax rate.

Some CDs, however, can be taxed differently. Uncle Sam has laws in place to encourage you towards building up your savings for certain life events, including retirement, education and medical care.

Retirement account CDs

“If you open a CD within a retirement savings plan like an IRA or 401(k) you don’t have to pay taxes on the earned interest until you withdraw the funds for retirement,” said McClary. 

For the retirement accounts to which you make pre-tax contributions — such as traditional IRAs and 401(k)s — any yields earned on those investments are also tax free until you make withdrawals, which is when you’re taxed on the entire amount withdrawn.

Roth IRAs are different — your investments here are made with funds on which you already paid income tax. In this case, taxes don’t apply to your earnings as long as you stick to the qualification rules. This IRS tool helps you determine whether your Roth distribution is taxable. 

CDs in educational and medical savings accounts

If you want to help your kiddo (or yourself) save up for education costs, 529 savings plans are especially designed to help do that. Your contributions are made with after-tax dollars (at least federally — your state may allow contributions to be tax deductible), but any yield, including CD interest, is not taxable when you make qualified withdrawals. 

Similar to Roth IRAs and 529 plans, yields earned on investments in health savings accounts (HSAs) also aren’t taxable — if you follow the rules. 

Inherited CDs

You have to pay taxes on inheritances, but it doesn’t count as part of your typical income. 

“An inherited CD’s income accrued before the original owner’s death is not taxable for the person who inherits the CD. Instead, the recipient is only responsible for the interest incurred from the original owner’s death until the CD’s maturity.” Said Shay James, a CPA, accredited financial counselor and IRS enrolled agent based in Bellingham, Wash. 

Early withdrawal penalties and taxes

Typically, if you withdraw your money from a CD before it matures, you have to pay an early penalty. The exact fees depend on the terms of your specific CD and the financial institution. 

The good news is that if you pay a penalty for removing your money from a CD early, you can write off the early withdrawal penalty on your federal taxes. This does not change the amount of interest you must report, but it does allow you a bit of an income tax break. 

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Reporting CD interest on your tax return

When tax season rolls around, you’ll need to report your CD interest on your tax return. If you earned $10 or more in interest over the year, your financial institution must send you the 1099-INT form by January 31. They’ll also send a copy to the IRS. 

On your 1099-INT form, you’ll see:

If your CD provider is a credit union, you’ll receive Form 1099-DIV, which is essentially identical except that it will say “dividends” instead of “interest.”

CD alternatives

Other deposit accounts

High-yield savings accounts can offer yields competitive to CDs and have the added benefit of being liquid.

“You can access your money anytime,” said Kathryn Kubiak-Rizzone, certified financial planner (CFP), NAPFA Advisor Bureau Member and founder of About Time Financial Planning based in Rochester, NY.

However, savings account rates can change at any time, for better or worse, while CD yields are locked in for the entire term. Many savings accounts also don’t allow easy access to your funds — you often need to transfer money to a checking account to spend it. 

To have a high yield and more convenient access, you might consider a money market account. This is an investment account that features many of the same benefits as checking and savings accounts, such as access to ATMs and competitive yields. 

Their downsides?

“Money market accounts often have higher minimum balance requirements and their interest rates are variable,” said Kubiak-Rizzone.

Both high-yield savings and money market accounts can be covered by federal deposit insurance; both can be subject to the same type of interest income tax as CDs. 

Investments 

You could take a crack at investing stocks, bonds, mutual funds and other vehicles available on the stock market. Depending on your goals, risk appetite and overall portfolio balance, you could go for the best low-risk investments, the best growth stocks or something else entirely.

These types of investments are taxed differently from deposit accounts. They’re instead subject to the capital gains tax, which ranges from 0% to 37% depending on your filing status and income, and whether the specific investment counts as short- or long-term.

Frequently asked questions (FAQs)