How to Avoid Taxes on CD Interest

Certificates of deposit (CDs) are a popular low-risk savings vehicle. But it’s important to consider that the interest they earn is fully taxable as ordinary income. Even if you don’t withdraw the interest until the CD matures, the IRS still expects you to report and pay taxes on it annually. While avoiding taxes altogether may not always be possible, there are several legal strategies that can help you reduce your tax liability and make the most of your CD earnings.

A financial advisor can also help you identify opportunities to protect your interest income through smart financial planning. 

5 Strategies to Avoid Taxes on CD Interest

While you may not be able to eliminate taxes on CD interest entirely, there are several strategies you can use to reduce or defer the tax burden. Depending on your situation, you may benefit from combining multiple strategies. A financial advisor can help assess which options align with your financial goals and tax profile.

1. Use Tax-Advantaged Accounts

One of the most effective ways to avoid immediate taxation on CD interest is to invest through a traditional IRA. Many banks and credit unions offer IRA CDs. These function like regular CDs but are held within a tax-deferred IRA.

With a traditional IRA, you won’t owe taxes on the interest until you make withdrawals in retirement. At this point, you may be in a lower tax bracket. With a Roth IRA, qualified withdrawals, including interest, are completely tax-free. However, you’ll pay income tax on the money before it goes into your account.

This makes IRA CDs a great option for those looking to save for retirement while reducing or delaying tax liability on their interest earnings.

2. Time CD Maturities to Spread Income Over Years

Another strategy is to stagger CD maturities so you don’t receive a large amount of interest income all at once. Even though CD interest is usually taxed each year as it accrues, having several CDs mature in the same year could mean a big payout of principal and interest during a time when you might also have other income. This could push your total income higher in that year. Spreading CD maturity dates over different years can help manage when you receive the money and make it easier to plan around other income events, like retirement payouts, bonuses, or selling property. 

Laddering CDs with different terms is one way to do this while still keeping access to some of your money and earning interest.

3. Invest in U.S. Treasury Securities Instead of CDs

If your primary goal is to earn interest with minimal tax exposure, consider U.S. Treasury securities as an alternative to CDs. While they are not technically CDs, Treasury securities serve a similar purpose in the portfolio as low-risk, fixed-income investments. The key difference is that interest from Treasury bonds, bills and notes is exempt from state and local income taxes.

Although you’ll still pay federal income tax on the interest, avoiding state and local taxes can result in meaningful savings. This is especially helpful for residents of high-tax states. You can purchase Treasury securities directly through TreasuryDirect.gov or through a brokerage account.

4. Offset Interest Income With Tax Deductions or Credits

If you can’t avoid earning taxable interest, you may be able to offset it by increasing your deductions or claiming available tax credits. For example, contributions to a traditional IRA, HSA (health savings account) or 401(k) can reduce your taxable income. This could potentially help offset your CD interest earnings.

You should note, however, that if you itemize deductions, you won’t be able to deduct investment-related expenses or other qualifying costs in 2025 and after. While this doesn’t eliminate the tax on CD interest, it can reduce your overall tax liability. Coordinating deductions and credits with the timing of your CD interest can help create a more tax-efficient financial plan.

5. Gift CDs to Family Members in Lower Tax Brackets

Another common strategy is to gift CDs to family members who are in lower tax brackets, such as children or retirees, so that future interest is taxed at their rate instead of yours.

To do this, the CD must be transferred or opened in their name before it earns interest. You can gift up to $19,000 per person in 2026 without triggering the gift tax. This approach needs careful planning, especially if the recipient is a minor, since the kiddie tax may apply to their unearned income.

How CD Interest Is Taxed

The IRS considers interest earned on certificates of deposit ordinary income. As such, CD interest is taxed at the same rate as your wages, salary or other non-investment income. This applies regardless of whether you withdraw the interest or reinvest it back into the CD. 

You must report the income in the year it is earned, not necessarily when it is received. As a result, CD holders may owe taxes on interest they haven’t yet accessed, especially in the case of multi-year CDs that accrue interest over time.

Financial institutions are required to report interest income of $10 or more to the IRS using Form 1099-INT, which you’ll receive at tax time. Even if your bank doesn’t issue a 1099-INT (for example, if the amount earned is less than $10), you are still legally required to report that income. 

Get a quick estimate of your tax bill before filing by entering your details into our income tax calculator.

CDs With Terms Longer Than One Year

When you purchase a CD with a term longer than one year, such as a 3- or 5-year CD, you may think you can delay taxes until the CD matures and you withdraw the funds. However, the IRS requires you to report the interest annually as it accrues, even if you do not receive or access the funds until the end of the term. This is known as constructive receipt. It prevents taxpayers from deferring income to future years by locking it into a longer-term investment.

This means you’ll owe taxes each year based on the amount of interest credited to your CD account, even if the CD is not liquid and you don’t receive the funds. For savers who aren’t expecting this, it can be an unwelcome surprise. This is why it’s important to track your CD’s interest earnings annually and prepare for the associated tax liability.

CDs With Terms of One Year or Less

CDs with terms of one year or less are generally easier to manage for tax purposes, but they don’t always fit neatly into a single calendar year. For example, a 6-month CD opened in November will mature in the following year, so the interest may be split across two tax years. On the other hand, if the CD starts and matures within the same year, such as one opened in January and maturing in June, all the interest is reported in that tax year.

In most cases, when a short-term CD begins and ends in the same calendar year, the full amount of interest will appear on that year’s 1099-INT. This makes it easier to track and report compared to longer-term CDs that span multiple years.

Even with shorter terms, CD interest is considered taxable income in the year it is earned. Depending on how much you earn, it could increase your total taxable income and affect your eligibility for deductions or tax credits.

Frequently Asked Questions

Bottom Line

If you’re earning interest from certificates of deposit, learning how to avoid tax on CD interest, or at least reduce it, can help protect your overall returns. While CD interest is generally taxed as ordinary income, there are strategic ways to defer, offset or minimize that tax burden. This involves using tax-advantaged accounts, timing tactics and portfolio planning. 

Tax Planning Tips

• A financial advisor can help you manage taxes for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you want to know how much you could pay in taxes for the sale on an investment, SmartAsset’s capital gains calculator can help you get an estimate.

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