A certificate of deposit, referred to as a CD, is a savings product that pays consumers a fixed interest rate over a set period of time, commonly six months to five years.
People commonly think of CDs as a conservative, low-risk financial product. Generally, this is true. But one aspect investors don’t think about with CDs is taxes.
The interest you earn on CDs is considered to be taxable income. Depending on your tax bracket, you could pay up to 37% to the IRS in federal taxes — plus any state and local taxes.
How much you’ll pay on taxes, and when those taxes are due, depend on the CD’s terms. Additionally, for some CDs like IRA CDs, you do not have to pay taxes.
How Are CDs Taxed?
You’ll pay the same rate of taxes on CD yields that you pay on your regular income tax rate.
So if you’re currently in a 24% tax bracket for your salary, then you would pay 24% taxes on any CD profit growth.
So if you bought a CD for $500 and then made a $75 return, you would pay a 24% tax rate on the $75.
This means CDs are taxed like ordinary income and not as capital gains, which is generally a more favorable rate.
How Do I Report CD Income?
As a taxpayer, you report interest from CDs on your federal income tax return.
A 1099-INT form will be issued by the financial entity issuing the CD if it yields an interest income of at least $10.
Any income is reported on line 2b of your individual income tax return 1040 form, including all CD income from all CD sources.
Is CD Interest Taxable Before Maturity?
Yes, you pay CD interest for the year that it is earned even if it’s before the year that the CD has fully matured.
Every year your CD account earns at least $10 in interest, and your bank or credit union will issue you a Form 1099-INT.
How Can I Avoid Paying Taxes on a CD?
One way consumers can avoid paying taxes on CD earnings is to purchase CDs in a tax-advantaged account like a Roth IRA or a 401(k).
CD returns grow tax-free year over year, but taxes will ultimately need to be paid when distributions are made — usually at retirement — but until then taxes will be deferred.
In addition to CDs in Individual Retirement Accounts (IRAs) and 401(k) plans, you can purchase CDs in 529 plans, Health Savings Accounts (HSAs), and other financial products.
If you have questions about taxable interest and tax liability on CDs, or personal finance in general, speak with a tax professional or financial planner.
Are Retirement CDs Tax Deductible?
The money you put into a traditional IRA CD is tax-deductible in the year that you make the contribution.
Earnings or returns on the CD are tax-exempt until you eventually withdraw the funds for retirement.
Contributions you make to a Roth IRA CD are not tax deductible, but the earnings are tax-free.
Who Can Issue CDs?
CDs are typically offered by banks and credit unions, however, you can also purchase them through brokerage firms or individual brokerage reps referred to as deposit brokers.
Brokerage CDs have a higher annual percentage yield (APY) than bank CDs and much longer terms. You may need to wait 10 to 20 years, or more, for the CD maturity date.
Are CDs Considered Assets?
Yes, a CD is considered an asset that is held by the issuing financial institution.
While the bank holds the CD, it gives the owner — CD purchaser — a specific amount of interest if the CD is invested for a set period of time, as per the CD’s term lengths.
A CD is designed to be a stable, short-term cash investment. Bank-purchased CDs are backed by the federal government, and covered by Federal Deposit Insurance Corporation (FDIC) insurance for up to $250,000.
Can You Lose Money Invested in a CD?
You can, however, lose interest if you withdraw bank or credit union-issued CD funds before their maturity date. Additionally, you may pay an early withdrawal penalty if you withdraw CD funds within a certain date of the account’s opening.
Brokerage firms, not member FDIC, may offer other high-yield CDs. These CDs are generally riskier, but brokerage accounts do offer Securities Investment Protector Corporation (SIPC) insurance.
Is Putting Money in a CD Worth It?
In many instances, yes. CDs usually offer much higher interest rates than savings accounts and savings bonds, and they can also outperform many money market accounts (MMAs).
Additionally, the best CD rates can outpace the Consumer Price Index (CPI) and may be a good hedge against inflation.
This means a CD may be worthwhile if you’re trying to save for a specific short-term goal, like a house down payment or a new car. And they can also help you meet retirement goals. CDs are commonly part of the investment mix for a low-risk, traditional IRA portfolio.
An accountant or tax professional can help you weigh out the pros and cons of your personal situation to determine whether or not CDs are worth it for you.
What Banks Offer the Highest CD APY?
New CD rates are always being published, but as of right now here is the best CD rate you can take advantange of today.