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Understanding Certificates of Deposit (CDs) and Their Tax Implications

At O1ne Mortgage, we aim to provide you with the best financial advice and services. If you have any mortgage-related needs, feel free to call us at 213-732-3074. In this article, we will explore how CDs work, how they are taxed, and how to report CD income on your tax return.

How Do CDs Work?

A Certificate of Deposit (CD) is a time-limited savings account that offers a fixed interest rate, usually higher than a regular savings account. Available at most banks and credit unions, CDs are known as share certificates at credit unions.

Common Attributes of CD Accounts

• Preset Terms: When you open a CD, you select a specific term for the account, such as three months, six months, nine months, 12 months, 18 months, three years, or five years.
• High Interest Rates: CDs typically offer higher interest rates compared to regular savings accounts, often comparable to high-interest savings or money market accounts.
• Early Withdrawal Penalties: Withdrawing funds before the CD term ends may result in forfeiting some of the interest earned.
• Low Risk: CDs at FDIC-insured banks or NCUA-backed credit unions are insured up to $250,000, providing a stable and predictable return.
• Modest Returns: While CDs offer safety, the returns are modest and won’t make you rich quickly, but they provide stability in a volatile market.

How Are CDs Taxed?

Interest income from CDs is taxed at the same rate as your ordinary income. For instance, if you are in the 22% tax bracket, 22% of your CD yield will go towards federal income taxes. This differs from capital gains taxes, which are generally lower.

How to Report CD Income on Your Tax Return

Your bank or credit union will issue a 1099-INT statement showing the interest earned on your CD for the year. Include this interest on Line 2b of your Form 1040. If your CD matures within the same year, all interest will appear on that year’s 1099-INT. For multiyear CDs, interest is reported incrementally at the end of each year.

How to Avoid Being Taxed on CD Earnings

Interest on CDs is generally taxable unless you open an IRA CD, a tax-advantaged account for retirement savings. You can choose between traditional and Roth IRA CDs. Contributions to a traditional IRA CD are tax-deductible, but withdrawals are taxed. Roth IRA CD contributions are not deductible, but earnings and withdrawals are tax-free.

If you opt for an IRA CD, remember to roll it into a new CD upon term expiration to avoid early withdrawal penalties and taxes.

The Bottom Line

Paying taxes on your CD yield is straightforward. Remember to look for your 1099-INT form in late January and include the interest information on your tax return. For concerns about tax liability on your savings and investments, consider consulting a financial or tax advisor.

For any mortgage-related needs, call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey with confidence.

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