A savings account is one of the best places to keep your spare cash. A savings account provides absolute safety and protection from loss, while at the same time allowing you to access your money whenever you need it. You should keep in mind, however, that the interest you earn on that savings account is added to your taxable income, so you will owe taxes on those funds when you complete your tax return. In the current low-interest-rate environment, however, the effects of taxes are likely to be small.
Personal vs. Tax-Deferred
If you hold your savings account in an IRA or other tax-deferred account, you will not owe taxes on the interest the account generates. Some people keep a portion of their retirement money in a savings account to protect their money from the ups and downs of the stock market. In that case, the interest is not taxable. But if you hold your savings account outside a tax-deferred retirement account, you will owe taxes on the interest generated by the account. The exact amount you owe is dependent on your tax bracket and your total taxable income.
At the beginning of each year you receive a 1099-INT form from each bank where you have an interest-bearing account. The 1099-INT form lists the amount of interest you received for the past year. You'll have to include this amount on your tax return when you file. The bank also sends a copy of each 1099-INT to the IRS, meaning when you file your taxes, you'll have to report the correct amount. The IRS uses a special matching program to verify that the amounts that banks report matches the amounts that taxpayers report.
If you have a significant amount of interest income, it pays to do a little advance tax planning to determine how much you might owe. Banks do not typically withhold taxes when they pay interest to their customers, so you are responsible for setting aside enough money to pay any taxes due. Use a tax preparation software package to run the numbers and determine how much you might owe when you file your taxes. If you do not yet have your 1099-INT forms, you can estimate the amount of interest by looking at the year-to-date interest figure on your most recent bank account.
Even if you have to pay taxes on the money earned in your savings account, you lose only a portion of those earnings to taxes. The higher your tax bracket, the more you have to pay, but a savings account can still be a good deal, particularly if you seek out an account with a competitive rate of interest. A high-yield savings account is an excellent vehicle for keeping your money safe, as long as the bank you use is fully insured by the FDIC. That makes a savings account a good place to stash cash for emergencies. Opening a high-yield savings account is also a good way to save up for a major purchase, like a new car or new home appliances.