Certificates of deposit (CDs) are often described as one of the safest places to park your money. When you open a CD at a bank or credit union that’s insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), your deposits are typically protected up to $250,000 per depositor, per institution.
But while CDs are simple and safe, the taxes on them can feel confusing. Let’s break it down in plain English so you know exactly what to expect.
Do You Pay Taxes on CD Interest?
Yes in most cases, you pay income tax on the interest your CD earns.
The Internal Revenue Service (IRS) treats CD interest the same way it treats interest from a savings account. It counts as ordinary income, which means it’s taxed at your regular income tax rate the same rate that applies to your wages.
Simple Example
Let’s say:
-
You invest $10,000 in a CD.
-
It earns $400 in interest during the year.
That $400 is added to your taxable income. If you’re in the 22% tax bracket, you’d owe $88 in federal income tax on that interest.
What Is Form 1099-INT?
If you earn more than $10 in interest from a bank or credit union during the year, you should receive Form 1099-INT by January 31 of the following year.
This form shows:
-
How much interest you earned
-
Any early withdrawal penalties
-
Federal taxes withheld (if any)
Even if you earn less than $10 and don’t receive a 1099-INT, you’re still required to report the income.
What Happens When a CD Matures?
When your CD reaches the end of its term (called “maturity”), the bank may:
-
Deposit the money into your checking or savings account, or
-
Automatically renew it into a new CD
Here’s the key point:
-
Your original deposit (principal) is not taxable.
-
Only the interest earned is taxable.
If you deposited $5,000 and it grows to $5,300 at maturity, only the $300 in interest is subject to tax.
Long-Term CDs: A Common Tax Surprise
If you open a CD that lasts more than one year say, a three-year CD taxes can get a little tricky.
Even if your CD doesn’t pay out interest until the end, the IRS usually requires you to report the interest each year as it accrues, not just when you receive it.
You may receive a Form 1099-OID (Original Issue Discount) showing how much interest accumulated during the year.
Example
You open a 3-year CD that pays all interest at maturity.
Even though you don’t see the money until year three, you may still need to:
-
Report interest in year one
-
Report interest in year two
-
Report the remaining interest in year three
This surprises many first-time CD investors.
What Tax Rate Applies to CD Interest?
There’s no special tax rate for CDs.
Your interest is taxed at your ordinary income tax rate, which depends on:
-
Your total income
-
Your filing status
-
Other deductions or credits
If your income changes from year to year, the tax you pay on CD interest may also change.
CDs Inside Retirement Accounts
If you hold a CD inside a retirement account like a traditional IRA, the tax treatment is different.
Traditional IRA CDs
You generally do not pay taxes each year on the interest earned inside the account.
Instead, you pay taxes later when you withdraw the money. At that point, withdrawals are usually taxed as ordinary income.
You’ll receive Form 1099-R for any retirement account distributions.
Important: With traditional IRAs, taxes usually apply to the entire withdrawal both your original contributions and the interest earned.
Roth IRA CDs
If your CD is inside a Roth IRA, things may be even better.
Qualified withdrawals from a Roth IRA can be completely tax-free, including the interest earned as long as you follow IRS rules about age and account holding periods.
Before taking withdrawals, it’s wise to confirm the details with a tax professional.
Can You Deduct Early Withdrawal Penalties?
CDs require you to keep your money locked up for a specific time. If you withdraw early, the bank usually charges a penalty.
Here’s some good news:
You can generally deduct the early withdrawal penalty on your tax return.
Even if:
-
The penalty wipes out all your interest, or
-
The penalty dips into your principal
You may still deduct the full penalty amount as an adjustment to income.
Check your 1099-INT or 1099-OID the penalty is often listed there.
When Do You Actually Pay the Taxes?
Most people pay CD-related taxes when they file their annual tax return in April.
However, if you earn significant interest income and expect to owe at least $1,000 in taxes, you may need to make quarterly estimated tax payments to the IRS.
If you’re unsure, a CPA or tax advisor can help you avoid penalties.
Can You Reduce Taxes on CD Interest?
If CD interest is pushing you into a higher tax bill, there are strategies to consider:
-
Holding CDs inside tax-deferred accounts like IRAs
-
Using tax-free accounts like Roth IRAs (if eligible)
-
Balancing taxable investments with tax-efficient investments
For example, some investors hold interest-paying assets in retirement accounts and keep more tax-friendly investments (like certain long-term capital gains assets) in taxable accounts.
Just remember: tax benefits should never be the only reason you choose an investment.
Why Do CDs Usually Pay More Than Money Market Accounts?
CDs often offer higher interest rates than money market accounts because:
-
You agree to lock up your money for a fixed period.
-
You give up flexibility.
Money market accounts let you deposit and withdraw funds more freely. Banks typically pay CD investors more to compensate for that reduced access to cash.
Please take a look at this as well:
Bank CD Rates Explained: Why They Change and How to Get the Best Return
