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Do I need to pay taxes on CD interest?

December 28, 2012

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

taxes on CD interest

Q: I haven't had a job in several years, so I don't file taxes. I have received money from my structured annuity, and would like to invest some of it in a CD. Do I have to pay taxes on the interest earned on a CD? If so, is there a certain minimum amount of income you need to earn before you have to pay taxes?

A: The most important point to be made here is that if you have income from any source, it may be subject to taxation. In other words, it's not just employment income that gets taxed; interest, dividends and investment gains are all taxable.

As you suspect, though, there is a minimum threshold of earnings necessary before you have to pay taxes. The size of that threshold varies depending on your circumstances, especially your age and marital status. The earnings threshold for taxation can be as low as $3,700 if you are married and filing a separate return from your spouse.

You should go to the IRS web site (www.irs.gov) and look at the instructions for Form 1040. These instructions include a table showing the different taxation thresholds depending on the taxpayer's status. Look in the section titled "Do You Have To File?" to see the applicable income threshold for your filing status. If your CD and other income (which may also include the annuity proceeds you mentioned) exceed that amount, you should file a return.

By the way, since you mention possibly investing in a CD, there are some other tips that you might find helpful. Like all bank interest rates, CD rates are very low these days, but making the right choices can help you get a little more for your money.

  1. Always shop to find the best CD rates. CD rates can vary greatly from one bank to another, so don't just settle for the first rate you find.
  2. Consider online banks for higher yields. Since CDs are a fairly passive type of investment, you may not need the type of personal service you can get from a local branch, and online banks frequently offer much better interest rates than traditional banks.
  3. Early withdrawal penalties are a key feature in today's interest rate environment. You can typically get a higher interest rate from a longer-term CD, but you may be hesitant to lock yourself in for five years at today's low interest rates. Finding a CD with a relatively small penalty for early withdrawal can be a way to benefit from a higher rate while leaving yourself some flexibility in case rates rise.

Good luck with finding a CD, and with working out the details of your tax filing status.

Got a financial question about saving, investing, or banking? MoneyRates.com invites you to submit your questions to its "Ask the Expert" feature. Just go to the MoneyRates.com home page and look for the "Ask the Expert" box on the lower left.

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