The interest your bank pays you is taxable income, but you have real ways to lower what you owe
The interest earned in a savings account counts as ordinary income on your federal tax return. The bank reports it to the IRS on a 1099-INT form, and you report it on your tax return. But you do not have to accept the full tax bill on that interest. The most direct methods are: moving money into accounts that earn tax-free interest, timing withdrawals to stay below income thresholds that trigger higher taxes, and using accounts specifically designed to shelter interest from taxation.
How much tax you actually pay depends on your total income for the year and your tax bracket. Someone in the 22% bracket pays roughly 22 cents in federal tax on every dollar of interest earned. Add state income tax, and that number climbs. The strategies below work because they either prevent the interest from being reported as taxable income in the first place, or they reduce your overall taxable income so the interest itself is taxed at a lower rate.
Key Takeaways
- High-yield savings accounts in IRAs and Roth IRAs earn interest that is not reported to the IRS as current income, though traditional IRA withdrawals are taxed later.
- A Roth IRA allows interest to grow and be withdrawn tax-free if you follow the account rules, making it the strongest option if you are under the contribution limit.
- Series I Bonds and Series EE Bonds defer federal tax on interest until you cash them, and the interest is tax-free if used for may have access to education expenses.
- Municipal bonds pay interest that is exempt from federal income tax, though the interest is still reported on your return and may affect other tax calculations.
- Keeping total income below certain thresholds can lower your tax bracket and reduce the rate at which your interest is taxed.
Using a Roth IRA to earn interest tax-free
A Roth IRA is the strongest tool available if you meet the income limits. You contribute after-tax dollars (money you have already paid income tax on), and then the account grows completely tax-free. Interest earned inside a Roth IRA is never reported to the IRS as income, and you can withdraw both the interest and your original contributions without owing any federal tax, provided you are at least 59½ years old and have held the account for at least five years.
The catch is contribution limits. For 2024, you can contribute up to $7,000 per year if you are under 50, or $8,000 if you are 50 or older. If your income exceeds certain thresholds, you cannot contribute directly to a Roth IRA. Those thresholds vary by filing status and change each year. A single filer with modified adjusted gross income over $161,000 in 2024 cannot contribute to a Roth IRA at all. If you are below the limit, a Roth IRA with a high-yield savings account inside it is the most tax-efficient way to earn interest on money you do not need when ready.
A traditional IRA defers tax but does not eliminate it
A traditional IRA works differently. You contribute pre-tax dollars (which may reduce your taxable income that year), and the interest grows without being reported annually. However, when you withdraw the money in retirement, the entire withdrawal is taxed as ordinary income. This is not tax-free growth—it is tax-deferred growth. You pay the tax eventually, but you delay it.
The advantage is that you may be in a lower tax bracket when you retire and withdraw the money. If you are currently in the 24% bracket and expect to be in the 12% bracket in retirement, deferring the tax saves you money. The disadvantage is that you cannot touch the money before age 59½ without paying a 10% early withdrawal penalty, plus income tax on the amount withdrawn. A traditional IRA makes sense if you want to reduce your current taxable income and believe you will be taxed at a lower rate later.
Series I Bonds and Series EE Bonds defer federal tax
U.S. savings bonds—specifically Series I Bonds and Series EE Bonds—allow you to defer federal income tax on the interest until you redeem the bond or it reaches final maturity. You do not report the interest each year; you report it only when you cash the bond. This is useful if you buy a bond now and plan to redeem it in a year when your income is lower, or if you want to push the tax bill into a future year.
Series I Bonds have an additional advantage: if you use the proceeds to pay for may have access to education expenses (tuition and fees at an accredited school), the interest is completely exempt from federal income tax. You must have been at least 24 years old when you bought the bond, and the bond must be in your name alone. Series EE Bonds offer the same education exclusion under the same conditions. Both bonds have a minimum holding period of one year, and you lose the last three months of interest if you redeem before five years. You can buy up to $10,000 per person per calendar year in electronic bonds through TreasuryDirect.
Municipal bonds pay interest exempt from federal tax
Municipal bonds are issued by states, cities, and local governments to fund public projects. The interest they pay is exempt from federal income tax. If you buy a municipal bond issued in your home state, the interest is also usually exempt from state income tax. This makes them attractive for people in high tax brackets who want to earn interest without reporting it as federal income.
The trade-off is that municipal bonds typically pay lower interest rates than taxable bonds, because the tax exemption is valuable to buyers. Whether a municipal bond makes financial sense depends on your tax bracket. Someone in the 37% federal bracket benefits much more from the tax exemption than someone in the 12% bracket. You can buy municipal bonds through a broker, and they are listed on the Municipal Securities Rulemaking Board website so you can compare rates. The interest is still reported on your tax return (on Schedule B), but it does not count as taxable income.
Timing withdrawals to stay in a lower tax bracket
If you have control over when you withdraw money from taxable accounts, you can time those withdrawals to keep your total income below the threshold for a higher tax bracket. Tax brackets are ranges: in 2024, a single filer pays 12% on income up to $11,600, then 22% on income from $11,601 to $47,150. If your interest income pushes you from the 12% bracket into the 22% bracket, you pay 22% on every dollar above the threshold.
By withdrawing less in a given year, or by deferring withdrawals to a year when you have less other income, you can keep your total income lower and avoid the higher bracket. This works best if you have flexibility in your income—for example, if you are self-employed or retired and can choose when to take distributions from retirement accounts. It does not work if your income is fixed (like a salary), but it is worth considering if you have any control over the timing of large withdrawals or sales.
High-yield savings accounts in tax-advantaged accounts
A high-yield savings account held inside a tax-advantaged account (an IRA, 401(k), or similar) earns interest that is not reported to the IRS as current income. The interest compounds inside the account without triggering annual tax bills. This is different from holding a high-yield savings account in a regular taxable brokerage account, where the interest is reported on a 1099-INT and you owe tax on it every year.
The limitation is the same as with IRAs: you have contribution limits, and you cannot withdraw the money before retirement age without penalties. But if you have money you do not need for many years, moving it into a high-yield savings account inside an IRA or 401(k) is a straightforward way to earn interest without paying annual taxes on it. Some employers offer high-yield savings options within their 401(k) plans, though this is less common than mutual fund or stock options.
Frequently Asked Questions
Do I have to report interest from a savings account if it is under $10?
The bank does not have to send you a 1099-INT if the interest is under $10, but you still owe tax on it. The IRS expects you to report all interest income, regardless of the amount. If you receive a 1099-INT, use that figure. If you do not receive one but earned interest, you can find the amount in your account statements and report it yourself.
Can I put money in a Roth IRA just to avoid taxes on savings account interest?
Yes, that is a legitimate use of a Roth IRA. Many people use Roth IRAs as high-yield savings accounts specifically because the interest grows tax-free. The only restrictions are the annual contribution limit ($7,000 for 2024 if you are under 50) and the income limits for direct contributions. If your income is too high, you may be able to use a backdoor Roth conversion, though that involves more steps.
What if I earn interest in multiple savings accounts?
All interest from all accounts is combined and reported on your tax return. If you have interest from three different banks, the total of all three is what you owe tax on. Each bank reports its portion on a separate 1099-INT, and you add them together when you file. Moving money between accounts does not reduce the total interest or the tax you owe on it.
Does interest from a money market account get taxed the same way as savings account interest?
Yes. Money market accounts, savings accounts, and money market funds all report interest on a 1099-INT and are taxed as ordinary income. The tax treatment is identical. The difference is in the interest rate and liquidity, not in how the IRS treats the income.
Can I deduct savings account interest as a loss on my taxes?
No. Interest income cannot be deducted or offset against other income. You report it as income, and that is the end of it. The only way to reduce the tax is to reduce the interest itself (by moving money to tax-advantaged accounts) or to reduce your overall taxable income through other deductions or credits.