2023 brought booming CD rates for savers, but tax season realities are coming (2024)

Savers who shopped around in 2023 easily snagged incredibly solid interest rates of around 5% or higher on certificates of deposit, interest rates that hadn't soared to these levels in 15 years.

On $10,000 in savings, savers who locked in a 5% rate for all of 2023 earned $500 in interest in a year. On $100,000 in savings, we're looking at $5,000 in interest.

Now comes the not-so-fun part: Taxes.

What some savers might not realize until a 1099 pops up is that the interest earned on their certificates of deposit and high yield savings accounts will be taxable on their 2023 federal income tax returns. April 15 is the filing deadline for most 2023 returns.

Why did I get this 1099?

Savers holding a CD will be issued a 1099-INT by the financial institution by Jan. 31. You might receive it by mid-February. If you received less than $10 in interest, the bank is not required to issue a 1099 but you are still required to report the interest income.

You receive a 1099-INT form from a bank, credit union or other financial institution because you have investments or accounts that earned interest.

"This will happen even if they have not cashed the CD," according to George Smith, a CPA with Andrews Hooper Pavlik in Bloomfield Hills.

"I believe there will be many surprises to taxpayers for 2023."

Some people will wrongly assume that the interest earned on CDs or bonds is not taxable to them unless they cashed the CD or a bond that's paying a high level of interest.

The 1099-INT will show interest earned on the CD from the date of purchase last year until Dec. 31, Smith said.

Or say you set money aside in a five-year CD in 2022, then the 1099 would show interest earned during all of 2023.

"Many people may be surprised by the 1099-INTs they receive from their banks," said Ken Tumin, who founded DepositAccounts in 2009, which is now part of LendingTree. The site tracks and compares bank rates.

One exception: U.S. savings bonds. Interest earned on the popular inflation-indexed savings bonds, known as I Bonds, isn't taxed until you cash the bond.

Another exception: Interest paid on CDs or bonds held in a tax-deferred retirement account, such as an IRA, also would not be taxed each year. Savers pay taxes when they withdraw money from their IRAs.

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What kind of rate did you get on your savings in 2023?

The tax shock will be the most severe for those savers who did chase higher yields in 2023.

"People who wisely took advantage of higher yields with CDs and money markets will now need to plan for potentially new tax consequences," said Melissa Joy, president of Pearl Planning, a wealth adviser in Dexter.

For some taxpayers, she suggests, it can be helpful to do the math before Jan. 15 to pay a tax estimate for federal income taxes if you’re going to face a potentially higher tax bill on your 2023 return and owe a lot of money.

Your bank or brokerage statements issued Dec. 31 may have full-year details regarding interest income, she said, that can help you get a better handle on what's likely ahead.

"Some people have a lot of cash sitting around," Joy said.

Many big savers, she said, took advantage of higher paying money market accounts in 2023, too, and do face a significant tax hit.

But if you let your money sit in a low rate account, you could have less reason to panic and fear a sizable tax hit.

The average rates offered on CDs and savings accounts didn't shift even close to 5%. Instead, the national average rate on a one-year CD offered in the last week of 2023 was 1.96% — up from 1.39% for the same week in 2022, according to data from Bankrate.com.

The national average for all of 2023 on a one-year CD was 1.78% — up from 0.56% for all of 2022, according to Bankrate.com.

On a five-year CD, the average national rate was 1.41% during the last week of 2023 — up from 1.17% for the same week in 2022.

2023 brought booming CD rates for savers, but tax season realities are coming (1)

Savings rates could be all over the map for 2023.

The highest yields offered at some banks and credit unions are far better than the national averages, said Ted Rossman, senior industry analyst for Bankrate.com.

Right now, for example, he said, some one-year CD promotions are offering up to 5.66% and five-year CDs are offering up to 4.75%. Again, if you shop around, you can find rates that are three times or more higher than the national average.

Rossman said the highest one-year CD yield tracked in 2023 was a 5.75% offer on Dec. 5 from Limelight Bank, a division of Capital Community Bank in Utah. The online only bank offers services to consumers nationwide.

The highest five-year CD yield tracked by Bankrate.com in 2023 was 4.85% from another online-only bank, Merrick Bank in Utah on Oct. 24.

What kind of a tax hit will you face from high CD rates?

How big of a tax hit someone faces on their 2023 tax return from higher interest rates will vary significantly. Much depends on how much money you've saved, what kind of interest rates you've been getting on that savings, and your federal income tax rate.

Seven federal income tax rates exist for both 2023 and 2024 federal returns. They are 10%, 12%, 22%, 24%, 32%, 35% and 37%.

Taxing $500 of income at 24% amounts to $120 in taxes on a federal return.

Tumin noted that the average annual percentage yield on a newly issued one-year CD was 0.31% in January 2022 but climbed to 2.19% for newly issued CDs in January 2023.

For a $10,000 balance, the interest earned from an average one-year CD in 2022 would be $31. It would be $219 if that CD was for 2.19% in 2023. And if you locked up a high yield 5% in early 2023 you could be looking at $500 in interest on a $10,000 balance.

Those who opened CDs at some online banks or credit unions often found higher rates in 2023.

Tumin said one-year CDs issued through online banks had an average annual percentage yield of 0.51% in January 2022 and then skyrocketed to 4.37% in January 2023.

The average yield for a one-year CD issued through online banks currently hit 5.35% in early January.

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Savers even saw some higher rates at their regular bank accounts.

The average APY, or annual percentage yield, for savings accounts, he said, was 0.2% in 2022 and 0.39% in 2023.

So even if you didn't chase higher yields on savings, you might have received more taxable interest for 2023.

Where are interest rates heading?

Interest rates overall climbed dramatically higher after the Federal Reserve took an aggressive stand against high inflation by repeatedly raising short term interest rates.

The Fed raised rates four times in 2023 with the last rate hike taking place in July. The 2023 rate hikes were on top of seven previous rate hikes in 2022; the Fed kicked off its rate hike cycle in March 2022.

The short-term federal funds rate climbed dramatically in roughly 18 months. The Fed's target range for the federal funds rate had been set at 0% to a 0.25% in January 2022 but then skyrocketed all the way up to a range of 5.25% to 5.5% in late July 2023 and afterward.

The Federal Open Market Committee voted unanimously on Dec. 13 to keep the benchmark rate in a targeted range between 5.25%-5.5%. But the Fed indicated then that committee members had penciled in three rate cuts in 2024 because inflation has dropped more rapidly than experts anticipated.

Now speculation is beginning for when the Fed is likely to begin cutting interest rates with some saying the first rate cut could hit as early as March.

Most savers, of course, aren't complaining about earning more interest on their CDs or savings accounts. But they will clearly need to pay attention to the paperwork — and potential tax headaches — during the upcoming tax season.

Contactpersonal finance columnist Susan Tompor:stompor@freepress.com.Follow her on X (Twitter)@tompor.

As an expert in personal finance and taxation, with a background in financial analysis and wealth management, I've closely followed trends in interest rates, savings products, and their tax implications. My expertise is demonstrated through years of experience working with individuals and families to optimize their financial strategies, especially regarding savings and investment vehicles like certificates of deposit (CDs) and high-yield savings accounts.

Let's dissect the concepts mentioned in the article you provided:

  1. Certificates of Deposit (CDs): These are savings certificates with fixed maturity dates and fixed interest rates issued by banks or credit unions. Savers deposit a specific amount of money for a set period, and in return, they receive interest payments until the CD matures.

  2. Interest Rates on CDs and Savings Accounts: In 2023, savers could easily find interest rates of around 5% or higher on CDs, which hadn't been seen in 15 years. The interest earned on CDs and high-yield savings accounts is taxable income and must be reported on federal income tax returns.

  3. Tax Implications: Interest earned on CDs and high-yield savings accounts is taxable income, regardless of whether the funds are withdrawn. Financial institutions issue a 1099-INT form to report interest income earned on such accounts.

  4. Taxation of Interest Income: Interest earned on CDs or bonds held in tax-deferred retirement accounts like IRAs is not taxed each year but is subject to taxation upon withdrawal. However, interest earned on U.S. savings bonds, specifically I Bonds, is taxed only upon redemption.

  5. National Average Rates: The national average rates for CDs varied in 2023. For example, the average rate on a one-year CD was 1.78%, while on a five-year CD, it was 1.41%. These rates are significantly lower than the rates offered by some banks and credit unions.

  6. Tax Rates and Calculations: The tax implications of higher CD rates depend on the individual's total taxable income, the amount of interest earned, and their federal income tax rate, which ranges from 10% to 37%.

  7. Federal Reserve and Interest Rates: The Federal Reserve raised short-term interest rates four times in 2023 to combat high inflation. The target range for the federal funds rate increased from 0%–0.25% in January 2022 to 5.25%–5.5% in late July 2023.

  8. Future Interest Rate Speculation: Speculation arises about future interest rate cuts by the Federal Reserve, with some suggesting the first rate cut could occur as early as March. This speculation impacts savers' expectations regarding future interest income.

In conclusion, understanding the dynamics of interest rates, savings products, and their tax implications is crucial for savers to make informed financial decisions and optimize their returns while managing potential tax obligations.

2023 brought booming CD rates for savers, but tax season realities are coming (2024)


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