If you’ve ever invested money in stocks or mutual funds, you’re likely aware that capital gains (and losses) come in two flavors: short-term and long-term. And the time you notice this is usually during tax season, since the two types are taxed differently.
But what if you’ve invested some of your savings in safer certificates of deposit? CDs come in short and long terms, and everything in between, so do their tax rates vary?
The answer lies in how CD returns are classified. Unlike stocks and mutual funds, which grow through dividends and price appreciation, or capital gains, what you earn on CDs is interest income. And when it comes to interest income on your tax return, the IRS employs a “one size fits all” policy.
That means it makes no difference whether your earnings are from a 6-month certificate or a 6-year certificate, or even a savings or money market account. Interest income is interest income, period.
You may also wonder when CD earnings become a taxable event. Does it depend on when you cash out the CD or when it matures? Again the answer is no, as certificate earnings become taxable whenever the bank or credit union applies the interest — usually monthly or quarterly — regardless of when you withdraw it.
One exception is CDs opened within an IRA. Because the same rules apply to all IRA investments, interest earned on retirement CDs is not taxable until the funds are dispersed post-retirement.
Whether you own one certificate or a portfolio of dozens, the tax implications of CDs are straightforward, and unfazed by any attempt to strategize term lengths. So invest in whatever CDs make the best sense for you, and know that your bank will report the interest income lump sum in time for tax seasons.