Pay tax on interest earned from Savings?

[ajknox]

Hi everyone,
I have heard this here and there and I want to confirm it. Do we have to pay taxes on all money accrued due to interest earned in savings? Eventually my plan is to get about $30k in my HSBC savings at 5.18% which would mean that end of the year I would have earned about $1.5k in interest in a year. Does that mean that I have to report this $1.5k and pay taxes.

[anonymous_saver]

Yes. You are required to report the interest on your 1040's.

[QueenOphelia]

.....and your bank will send you a 1099 stating they are reporting this interest to the IRS.

[disneysteve]

Yep, that is taxable income. As noted, the bank will send you a 1099-INT at tax time. Investment dividends and capital gains are also taxable, though the capital gains rules are different as far as the tax rates.

[ajknox]

How do you all generally handle this situation? Do you invest the money (either way pay taxes when you sell stock) or what are some other options. Uncle sam takes enough of my paycheck as it is, that now he has to come after my hard earned savings interest too...

[cptacek]

you just have to do it. It is never a good idea to let the taxes you have to pay be the only reason to make a financial decision. That's called letting the tail wag the dog.

The taxes you pay will not take all of the interest you earn away. We aren't taxed at 100%! So, if you are trying to decide if you are going to put the money under your mattress or in a savings account, then go with the savings account.

Of course, you need to be taking advantage of your 401(k), that will reduce your taxable income. An IRA will as well. But, this money is your liquid money, the money you can get at at a moment's notice, so you don't want to tie that up in those long-long-long term investments.

[disneysteve]

How do you all generally handle this situation?

I pay the taxes. Not really any other option. Fortunately, I've never needed to liquidate holdings to get the money to pay the taxes due though I'm sure there are times when that happens for some folks.

[wellheeled]

You could put the money in an tax-exempt fund that is free from federal and/or state taxes. The yield is lower but it often makes more sense for high tax-bracket investors (25% or 28% and higher) to use these accounts instead. Go to Vanguard.com, and search for "tax-exempt money market."

But you have to careful about the AMT because many of these funds have private activity bonds that is subject to the AMT.

[Like2Plan]

How do you all generally handle this situation? Do you invest the money (either way pay taxes when you sell stock) or what are some other options. Uncle sam takes enough of my paycheck as it is, that now he has to come after my hard earned savings interest too...

ajknox,
Going hand in hand with a savings goal is the other question: what do you want the money to do for you? For example, if the money is for a long term goal such as retirement (and your income is not too high to contribute), there is the Roth IRA which would make all your earnings tax free.

In the case of college savings, there are 529 plans in which the earnings are not taxed if used for a qualified purpose.

There are a bunch of tax deferred instruments (savings bonds, growth stocks, traditional IRAs. et'c), but then you have to have an exit strategy so that you don't end up paying a bunch of taxes all at once (and you can withstand market fluxuations over your savings time frame).

Are you saving for a short term goal in which you need the money to be fairly liquid and have a guaranteed rate of return?

-DC

[click4credit]

As already covered you will have to pay the taxes. However depending on your personal situation there may be better ways to structure your savings to avoid tax. If you have a home loan / mortgage then you could see if you can set up an offset account. In the case of you having $30k it would mean you don't pay interest on $30k of your mortgage. As your not directly earning interest there is no tax to pay and you may be much better off.

[kench]

You know the IRS people will always want their share. Unless this savings of yours is sitting in a retirement plan such as an IRA, then you have to pay taxes on the interest that you've earned.

[jmjj215]

As far as where the funds come to pay those taxes, you could withdraw them from the savings account itself, or cover its portion with other holdings. As the significance of the tax bill created by this account grew, that would become more fo an issue.