Taxes and Interest Income

Interest income is earnings generated by investments such as savings accounts, retirement plans, and certificates of deposit. Interest income you receive from any kind of interest-paying account can be either taxed (taxes paid when money is earned) or tax-deferred (taxes paid later) depending on what type of account you are putting your money into. Let's take a look at the different options of taxed and tax-deferred account types:

Taxed Accounts

Savings Account - This type of account will be through your bank typically, and earns very little interest income

Money Market Accounts - Similar to a Savings Account, however, you can write checks from this type of account

Dividends on Stocks and Bonds - Payments made by a company to the owners of a company's stock or bond

Certificates of Deposit (CD) - A product offered by financial institutions (usually banks) that offers a higher interest rate in exchange for the customer agreeing to leave a lump-sum deposit untouched for a period of time (6 months, 1 year, 18 months, etc.)

Tax-deferred options:

IRAs - Traditional IRAs (earnings are taxed deferred until withdrawn) or Roth IRAs (money invested is taxed before entered into the account and not taxed upon withdrawal)

401(k), 403(b) and 457 plans- The most common types of employer-sponsored retirement savings plans – named for the Internal Revenue Service tax codes that govern them. Employers sometimes will match employees’ contributions up to a certain amount or percentage. Each plan is available to certain specified groups:

401(k) plans are offered to employees of public or private for-profit companies.

403(b) plans are offered to employees of tax-exempt or non-profit organizations, such as public schools, colleges, hospitals, libraries, philanthropic organizations, and churches.

457 plans are offered to employees of state and local municipal governments (and some local school and state university systems).

College 529 plan - these are plans usually offered by states that allow you to earn interest on money set aside for future college tuition and expenses. These plans are not taxed, but if not used for college costs, the contributor will suffer penalties if withdrawn instead of being used for college.

HSA plan - a Health Savings Account allows you to set aside money in an interest-bearing account that is deducted from your paycheck and managed either by your employer or third party organization. The money deducted is not taxed, but it must be used to cover health care costs. Any excess funds not used over a set time period are forfeited after the set time expires.

Thrift Savings Plans - tax-deferred retirement savings and investment plans that offer Federal employees the same type of savings and tax benefits that many private corporations offer their employees under 401(k) plans. By participating in the TSP, Federal employees have the opportunity to save part of their income for retirement, receive matching agency contributions, and reduce their current taxes.