Tax considerations for certificate of deposit (CD) investors

Certificates of deposit offer guaranteed returns, but there’s one guarantee many investors forget about: You’ll owe taxes on the interest you earn. The IRS treats CD interest as taxable income, and you’ll need to pay taxes on it every year — even if your CD hasn’t matured yet and you can’t access the money.

Understanding how CD taxes work helps you plan better and avoid surprises come tax season. The good news is that there are strategies to minimize or even eliminate taxes on CD interest if you know what to do.

Here’s everything you need to know about CD taxes and how they might affect your investment returns.

How CD interest gets taxed

The IRS considers CD interest as ordinary income, just like the money you earn from your job. This means you pay taxes on CD interest at your regular income tax rate, not the lower capital gains rate that applies to some investments.

You owe taxes on CD interest in the year it’s earned, regardless of whether you actually receive the money. If you earn $10 or more in interest during the year, your bank will send you Form 1099-INT showing how much interest you earned. Box 1 on this form shows your taxable interest income. Even if you don’t receive a 1099-INT, you’re still required to report any interest earnings of $10 or more.

The tax rate you pay depends on your total income and tax bracket. CD interest gets added to your other income and taxed at ordinary income rates, which can range from 10% to 37% for federal taxes, plus any applicable state taxes.

Do you pay taxes on CD interest before maturity?

Yes, you pay taxes on CD interest every year it’s earned, even if your CD hasn’t matured yet. This applies regardless of whether you can actually access the money.

For CDs longer than one year, you’ll receive a 1099-INT each year showing the interest earned during that calendar year. For example, if you buy a five-year CD earning 4 percent annually, you’ll owe taxes on roughly one-fifth of your total interest each year for five years.

For CDs of one year or less, you typically pay taxes once when the CD matures or in the year you earned the interest, whichever comes first. However, if a short-term CD spans two calendar years, you might owe taxes in both years based on when the interest was actually earned.

This annual tax obligation can be frustrating since you can’t access the money to pay the taxes, but it’s how the IRS treats all accrued interest on fixed-income investments.

Tax planning tool

Calculate your potential after-tax CD returns using Bankrate’s CD calculator to compare different terms and rates.

What counts as taxable income when you cash in a CD?

When your CD matures, only the interest you earned counts as taxable income — not your original investment amount. This is because you already paid taxes on the money you initially deposited into the CD.

Here’s how it works: If you invested $10,000 in a CD that earned $500 in interest, you’ll receive $10,500 when it matures. Only the $500 in interest is taxable income. Your original $10,000 principal is considered a return of your own money.

The bank will report this $500 in interest on your 1099-INT, and you’ll need to include it on your tax return. If you’ve been paying taxes on the interest each year as it accrued, you should have already paid taxes on most or all of this amount.

This principle applies regardless of what you do with the money when the CD matures — whether you withdraw it, transfer it to another account or roll it into a new CD.

How early withdrawal penalties affect your taxes

If you withdraw money from a CD before it matures, you’ll typically pay an early withdrawal penalty. The silver lining is that this penalty can reduce your tax bill.

Early withdrawal penalties are tax deductible, even if the penalty exceeds the interest you earned. For example, if your CD earned $50 in interest but you paid a $100 early withdrawal penalty, you can deduct the full $100 from your taxes.

The bank will report early withdrawal penalties in Box 2 of your Form 1099-INT. This deduction is taken “above the line,” meaning it reduces your adjusted gross income regardless of whether you itemize deductions.

This tax benefit partially offsets the sting of early withdrawal penalties, though it’s still better to avoid breaking CDs early if possible.

Related reading: Understanding early withdrawal penalties and when they might be worth it

How to avoid taxes on CD interest

While you can’t escape taxes on regular CDs, there are several ways to avoid or defer taxes on CD interest.

IRA CDs: The most common tax shelter

Many banks offer CDs that you can hold inside Individual Retirement Accounts (IRAs). These work exactly like regular CDs but with significant tax advantages.

Traditional IRA CDs let you deduct your contribution from current taxes and defer all taxes until you withdraw the money in retirement. The CD interest grows tax-free while it’s in the account.

Roth IRA CDs don’t give you an upfront tax deduction, but all growth — including CD interest — is completely tax-free when you withdraw it in retirement.

For 2025, you can contribute up to $7,000 to an IRA ($8,000 if you’re 50 or older). This strategy works best if you’re already planning to make IRA contributions and want the safety of CDs rather than market-based investments.

Compare options: Best IRA CD rates for tax-advantaged savings

Health savings account (HSA) CDs

If you have a high-deductible health plan, you might be able to put CDs in a Health Savings Account. HSA contributions are tax-deductible, growth is tax-free and withdrawals for medical expenses are also tax-free.

Some banks offer CDs specifically designed for HSAs, though the selection is limited. The main downside is that you might face early withdrawal penalties if you need the money for a medical emergency before the CD matures.

HSAs have contribution limits ($4,300 for individuals and $8,550 for families in 2025) and specific eligibility requirements based on your health insurance plan.

529 Education Savings Plan CDs

If you’re saving money to pay for education expenses, some 529 plans offer CD options. Money in 529 plans grows tax-free, and withdrawals for qualified education expenses are also tax-free at the federal level.

The downside is that 529 CDs typically offer lower rates than regular CDs, and your investment options are limited to what your specific 529 plan offers. Also, non-qualified withdrawals face taxes plus a 10% penalty on the earnings.

Calculating your after-tax CD returns

Understanding your actual after-tax return helps you make better investment decisions and compare CDs to other options.

The formula is simple: After-tax yield = CD yield × (1 – your tax rate)

For example, if you’re in the 22% tax bracket and earn 4% on a CD, your after-tax return is 4% × (1 – 0.22) = 3.12%.

This calculation helps you compare CDs to other investments like municipal bonds, which may offer lower yields but are often tax-free. It also shows why high-yield savings accounts might sometimes be more attractive than CDs, especially if they offer similar rates with more flexibility.

Don’t forget to include state taxes in your calculation if your state taxes interest income. Some states don’t tax interest, while others have rates that can significantly impact your returns.

State tax considerations

State tax treatment of CD interest varies significantly depending on where you live.

No state income tax states like Florida, Texas, and Washington don’t tax CD interest at all, meaning you only owe federal taxes.

States with income taxes generally treat CD interest the same as ordinary income, but rates vary widely. Some states have flat rates, while others use progressive tax systems similar to federal taxes.

Special situations exist in some states. For example, some states don’t tax interest from in-state banks or credit unions, while others offer deductions for retirement income that might include CD interest.

Check your state’s specific rules or consult a tax professional if you have substantial CD investments, as state taxes can significantly impact your overall returns.

Planning strategies for CD investors

Smart tax planning can help you maximize your CD returns and minimize surprises at tax time.

• Consider CD laddering not just for interest rate management, but also for tax planning. Spreading CD maturities across multiple years can help manage your taxable income and potentially keep you in lower tax brackets.
• Time your CD purchases around your tax situation. If you expect to be in a lower tax bracket next year, you might delay CD purchases. Conversely, if you expect higher taxes in the future, locking in current rates might make sense.
• Plan for the tax bill by setting aside money to pay taxes on CD interest you can’t access yet. This is especially important for longer-term CDs where you’ll owe taxes for several years before you can access the principal.
• Consider tax-loss harvesting in other parts of your portfolio to offset CD interest income if you have investments that have lost value.

Bottom line

With a fixed rate of return and a predetermined term length, it’s easy to calculate your earnings from a CD down to the exact cent. However, don’t forget to factor in the potential for handing over some of those earnings to the government. The IRS looks at CD interest as income, so you’re likely not going to be able to keep all of the cash when it matures. If you’re aiming to avoid paying taxes on CD interest, talk to a tax professional about incorporating CDs into your long-term saving strategy.