The increasing interest rates in the US have led to a surge in the amount of cash Americans are investing in high-yield savings accounts, certificates of deposit, and money-market accounts. While this may seem like a great deal, there are potential consequences that investors should be aware of. Retirees, in particular, may face unintended consequences such as being pushed into a higher tax bracket, increased taxation of Social Security, and surcharges on Medicare premiums. Additionally, individuals who have accumulated a large amount of cash and earned substantial income from it may find themselves owing more in taxes than usual when filing their federal tax return. As a result, it may be wise to consider paying advance quarterly tax payments.
The amount of tax individuals pay on their interest income varies based on their overall income, and it is important to note that interest income is taxed yearly, regardless of the transactions involved. State taxes may also be applicable. For retirees with a significant amount of cash, their tax bill on the interest income earned can be substantial, potentially adding thousands of dollars to their tax liability. While nobody enjoys paying taxes, some experts argue that it is a good thing to pay tax on investment gains and that individuals should focus on the fact that there is finally yield available.
To reduce the tax burden on interest income, investors have various options. Municipal bonds, although not currently paying enough to be a viable alternative, can sometimes be triple-tax-free. Treasury bonds are another option and are typically tax-free at the federal level and sometimes at state levels. Series I bonds are only taxable when cashed in, and certain tax can be avoided if the funds are utilized for specific purposes like paying for college. Investors can also consider investing in Treasury ETFs or other cash-equivalent securities that generally do not have a tax impact until sold. Additionally, offsetting investment and interest income gain with losses and carrying over losses on tax returns against ordinary income can help reduce the tax liability. It is crucial for investors to be aware of their potential tax obligations and to plan ahead to ensure a tax-efficient strategy.