The main ways to lower what you owe on savings interest

You pay federal income tax on savings account interest at your ordinary tax rate — the same rate as your salary or wages. The interest your bank reports on your 1099-INT form counts as taxable income. You cannot avoid this tax entirely if you earn interest, but you can reduce it by moving money into accounts or investments that produce interest tax-free or tax-deferred, by timing deposits and withdrawals to control which year interest posts, or by using deductions that lower your overall taxable income.

The strategy that works best depends on how much interest you earn, what tax bracket you are in, and how long you can leave money untouched. A person earning $500 a year in savings interest has fewer options than someone earning $5,000, and someone in the 22% tax bracket benefits differently than someone in the 12% bracket.

Key Takeaways

  • High-yield savings accounts and money market accounts earn more interest than traditional savings accounts, but the interest is still taxable at your ordinary income tax rate.
  • Roth IRAs and Roth 401(k)s let interest and investment gains grow completely tax-free, and you pay no tax when you withdraw the money in retirement.
  • Treasury bills, notes, and bonds are taxed only by the federal government, not by your state or city, which can save you 5 to 10 percent depending on where you live.
  • Municipal bonds pay interest that is usually exempt from federal tax and sometimes from state tax, but they are not right for everyone and require a larger initial investment.
  • Timing large deposits or withdrawals to split interest between two tax years can lower your tax bracket and reduce the total tax you owe.

Tax-free growth accounts: IRAs and 401(k)s

A Roth IRA is the simplest way to earn interest without paying tax on it. You contribute money you have already paid tax on, and then all interest, dividends, and investment gains grow tax-free. When you withdraw the money in retirement — at age 59½ or later — you owe no tax on any of it. For 2024, you can contribute up to $7,000 per year to a Roth IRA if you are under 50, and $8,000 if you are 50 or older. There are income limits: if you earn too much, you cannot contribute the full amount or may not be able to contribute at all.

A Roth 401(k) works the same way but is offered through your employer. Contributions go in after tax, and withdrawals in retirement are tax-free. The contribution limit is much higher — $23,500 per year for 2024 if you are under 50 — but you need an employer plan to use one. Some employers match contributions, which means assistance programs that also grows tax-free.

A traditional IRA or 401(k) defers tax instead of eliminating it. You get a tax deduction for contributions now, which lowers your taxable income this year, but you pay tax on withdrawals in retirement. This is useful if you expect to be in a lower tax bracket when you retire, but it does not save you tax on the interest itself — only delays it.

Treasury securities: federal tax only, no state or local tax

Interest from U.S. Treasury bills, notes, and bonds is subject to federal income tax but is exempt from state and local income tax. This can be a significant savings if you live in a state with a high income tax rate. For example, if you earn $1,000 in interest and live in California, you would normally owe federal tax plus California state tax. With Treasury securities, you owe only the federal tax.

You can buy Treasury securities directly from the U.S. Department of the Treasury through TreasuryDirect.gov at no cost. You can also buy them through a bank or brokerage, though you may pay a small fee. Treasury bills mature in four weeks to one year, Treasury notes mature in two to ten years, and Treasury bonds mature in twenty to thirty years. The longer the maturity, the higher the interest rate, but your money is locked in for that entire period.

Treasury securities are backed by the full faith and credit of the U.S. government, so they carry virtually no risk of default. The tradeoff is that the interest rate is lower than you might earn in a high-yield savings account or from corporate bonds. Whether the tax savings make up for the lower rate depends on your tax bracket and your state's tax rate.

Municipal bonds: federal tax-free interest, sometimes state tax-free too

Interest from municipal bonds — bonds issued by states, cities, and other local governments — is usually exempt from federal income tax. If you buy a bond issued in your own state, the interest is often exempt from state tax as well. This can save you 20 to 40 percent of the interest you earn, depending on your tax bracket and state.

Municipal bonds typically require a larger initial investment than savings accounts — often $5,000 to $10,000 per bond — and the interest rate is lower than corporate bonds because of the tax advantage. You can buy individual bonds through a broker or invest in a municipal bond fund or exchange-traded fund (ETF) with a smaller amount of money. Bond funds carry interest rate risk: if rates rise, the value of existing bonds falls, and you may lose money if you sell before maturity.

Municipal bonds are not right for everyone. If you are in a low tax bracket, the tax savings are small and may not be worth the lower interest rate. If you live in a state with no income tax, federal tax exemption is the only benefit. A financial advisor or tax professional can help you decide whether municipal bonds make sense for your situation.

High-yield savings accounts and money market accounts

High-yield savings accounts and money market accounts earn significantly more interest than traditional savings accounts — sometimes three to five times as much — but the interest is still fully taxable at your ordinary income tax rate. They do not reduce your tax burden, but they do increase the amount of interest you earn before tax, which means you have more money overall even after paying tax.

The interest rate on these accounts changes frequently and varies by bank. You can compare current rates on sites like Bankrate or DepositAccounts. The tradeoff is that some high-yield accounts have monthly fees, require a minimum balance, or limit the number of withdrawals you can make per month. Read the fine print before opening an account.

High-yield savings accounts are useful as a holding place for money you need to access quickly — an emergency fund, for example — while you decide whether to move larger amounts into tax-advantaged accounts. They are also a good option if you have already maxed out your IRA or 401(k) contributions for the year.

Timing deposits and withdrawals to split interest between tax years

Interest accrues throughout the year but is reported on your 1099-INT form based on the calendar year in which it was credited to your account. If you make a large deposit late in the year, most of the interest will be credited in the following year, which can shift some of the tax burden to the next year. This is useful if you expect to be in a lower tax bracket next year — for example, if you are retiring or taking a sabbatical.

Similarly, if you withdraw money early in the year, you reduce the balance that earns interest for the rest of the year, which lowers the total interest credited that year. This strategy works only if you have flexibility about when you deposit or withdraw money and if you can predict your income for the coming year with reasonable accuracy.

This approach does not eliminate tax; it only postpones it or spreads it across years. It is most useful when combined with other strategies, such as moving money into a Roth IRA in a year when your income is lower than usual.

Deductions that reduce your overall taxable income

You cannot deduct interest you earn, but you can reduce your taxable income through other deductions, which indirectly lowers the tax you owe on that interest. The standard deduction — $14,600 for single filers and $29,200 for married filing jointly in 2024 — is subtracted from your income before tax is calculated. If your income is below the standard deduction, you owe no federal income tax at all, even if you earned interest.

If you itemize deductions instead of taking the standard deduction, you can deduct mortgage interest, state and local taxes (up to $10,000), charitable contributions, and certain medical expenses. A larger total deduction means a lower taxable income and less tax owed on your interest. Whether itemizing saves you money depends on your specific situation; many people save more by taking the standard deduction.

You can also reduce taxable income through contributions to traditional IRAs, health savings accounts (HSAs), and certain education savings accounts. These reduce your income before interest is added, which lowers the tax on the interest itself.

Frequently Asked Questions

Do I have to report interest if I earned less than $10?

Banks report interest of $10 or more on a 1099-INT form, but you must report all interest you earned, even if it is less than $10 and you did not receive a 1099-INT. The IRS expects you to report it on your tax return. If you earned interest from multiple banks and one of them did not send a 1099-INT, you are still responsible for reporting it.

Can I avoid taxes by keeping my savings below a certain amount?

No. You owe tax on all interest you earn, regardless of how much money you have in savings. There is no threshold below which interest becomes tax-free. The only way to avoid tax on interest is to move money into accounts that are specifically designed to be tax-free or tax-deferred, such as Roth IRAs or Treasury securities.

Is interest from a CD taxable?

Yes. Interest from a certificate of deposit (CD) is taxed the same way as interest from a savings account — at your ordinary income tax rate. The interest is reported on a 1099-INT form and must be included on your tax return. Some banks allow you to put a CD inside a Roth IRA, which makes the interest tax-free, but the CD itself does not reduce taxes.

What if I earned interest but did not receive a 1099-INT?

Contact your bank and ask them to send you a corrected 1099-INT. If they do not respond, you can still report the interest on your tax return based on your own records — your bank statements or the interest shown in your online account. The IRS has a record of the interest from the bank's copy of the 1099-INT, so reporting it yourself prevents a mismatch.

Does moving money to a different bank reset the interest I owe tax on?

No. Interest is taxed based on the calendar year in which it is credited to your account, not on which bank holds the money. If you move money from one bank to another mid-year, you still owe tax on all the interest credited that year, split between the two banks' 1099-INT forms.