Earning interest means a bank, credit union, or bond issuer pays you a percentage of the money you have on deposit or have lent them, in exchange for the use of your funds. Rates on common deposit accounts currently run from roughly 0.39% on a standard savings account to about 4% or more on high-yield options. Federal law counts that interest as taxable income, so what you actually keep depends on the account type, how often the interest compounds, and your tax bracket.1Office of the Law Revision Counsel. 26 U.S. Code 61 – Gross Income Defined
How the Payment Is Calculated
Two numbers drive every interest calculation: the principal (what you deposit) and the rate (the percentage the bank applies to that balance, usually over one year). A $10,000 deposit at 3% produces $300 over twelve months. A bigger principal earns more dollars at the same rate; a smaller principal at a higher rate can still beat a larger one at a lower rate.
The rate a bank advertises is nominal. It does not account for inflation. If your account pays 4% while inflation runs at 3%, your real return is closer to 1%.
Simple Interest vs. Compound Interest
Simple interest is calculated on the original principal alone. Deposit $5,000 at 3% simple interest and you earn $150 each year, every year. The balance grows in a straight line. This method shows up mainly on certain short-term loans and some fixed-income investments.
Compound interest applies the rate to both your original principal and any interest already credited. After year one on that $5,000 at 3%, you have $5,150. In year two, the 3% runs against $5,150 and produces $154.50. The gap widens each year.
How often the compounding happens matters. Daily compounding beats monthly, which beats quarterly, which beats annual, because the interest-on-interest cycle runs more times per year.
APY Is the Number to Compare
When shopping accounts, look at the Annual Percentage Yield rather than the stated interest rate. APY reflects the total you earn over one year after the compounding frequency is factored in. Federal regulations require banks to disclose APY on every deposit account, so it is the standardized figure for comparing offers.2eCFR. 12 CFR Part 1030 – Truth in Savings (Regulation DD) Two accounts with the same 4% stated rate can produce different APYs if they compound on different schedules.
Where You Can Earn Interest
Several products pay interest, with different rates, access rules, and risk levels.
- Standard savings accounts. Available at nearly every bank, with a national average around 0.39% APY as of early 2026. Modest returns, easy access.3FDIC. National Rates and Rate Caps
- High-yield savings accounts. Mostly offered by online banks. APYs can reach 4% or higher, roughly ten times the national average, with the same federal deposit insurance and typically no minimum balance.
- Certificates of deposit. You commit your money for a set term, from a few months to five years or more, at a fixed rate usually higher than a regular savings account. Withdrawing early costs you.
- Money market accounts. A blend of savings and checking, often with tiered rates that rise with the balance. Many allow limited check-writing or debit card use.
- Bonds. You lend money to a corporation or government entity; the issuer pays you interest at a set rate until maturity and then returns your principal. Treasury, municipal, and corporate bonds each carry different risk and tax treatment.
- U.S. savings bonds. Series I bonds pay a rate tied to inflation. Series EE bonds pay a fixed rate and are guaranteed to double if held for 20 years.
What Early Access Costs
Savings and money market accounts generally let you take your money out any time, though some banks charge a monthly maintenance fee (often $0 to $5) if the balance drops below a threshold. CDs are the product where early access has a real price.
Cash out a CD before its maturity date and the bank deducts an early withdrawal penalty from your interest. The amount varies by institution and term. A common structure is around three months of interest on a one-year CD and about six months of interest on a two-year CD, with longer terms carrying steeper penalties. If you pull the money very early in the term, the penalty can eat into your original principal. Check the specific terms in the account agreement before you open the CD.
How the IRS Taxes Interest Income
Interest is taxed at your ordinary income tax rate, which runs from 10% to 37% for the 2026 tax year depending on filing status and total taxable income. You owe tax on interest for the year it is credited to your account, even if you leave it sitting there and never withdraw a dollar.
What Gets Reported
A payer that credits you $10 or more in interest during the year must send you a Form 1099-INT showing the amount. You are required to report all taxable interest on your federal return regardless of whether you get a 1099-INT, including amounts under $10.4Internal Revenue Service. Topic No. 403, Interest Received If your total taxable interest for the year is more than $1,500, you also need to file Schedule B with your Form 1040.5Internal Revenue Service. About Schedule B (Form 1040), Interest and Ordinary Dividends
Not reporting can trigger penalties and additional interest charges from the IRS. If you fail to give the payer your correct taxpayer identification number, you can also end up subject to backup withholding, where the bank pulls a percentage of your interest and sends it to the IRS directly.4Internal Revenue Service. Topic No. 403, Interest Received
An Extra 3.8% for Higher Earners
Interest income counts as net investment income for the 3.8% net investment income tax, which applies on top of the regular income tax. The NIIT hits the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds a threshold: $250,000 for married couples filing jointly and qualifying surviving spouses, $200,000 for single filers and heads of household, and $125,000 for married individuals filing separately.6Internal Revenue Service. Topic No. 559, Net Investment Income Tax These thresholds are not adjusted for inflation, so more taxpayers cross them as incomes rise.
Interest That Escapes Some or All Tax
A few categories get better tax treatment, which can meaningfully change your after-tax return.
Municipal Bonds
Interest on bonds issued by state and local governments is generally excluded from federal gross income.7Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds That exemption is a big part of why municipal bonds appeal to investors in higher brackets, even though the stated rates are usually lower than comparable taxable bonds. Some exceptions exist, including private activity bonds that do not qualify under federal rules and arbitrage bonds, which remain taxable. Many states also exempt interest on bonds issued inside their own borders from state income tax, creating a potential double benefit; check your state’s rules.
U.S. Treasury Securities
Interest on Treasury bills, notes, and bonds is subject to federal income tax, but federal law exempts it from state and local income taxes.8Office of the Law Revision Counsel. 31 U.S. Code 3124 – Exemption From Taxation In a high-tax state, that can make a Treasury more attractive on an after-tax basis than a CD or savings account paying a similar nominal rate.
Education Savings Bonds
Interest on Series EE and Series I savings bonds issued after 1989 may be fully excluded from federal income tax if you use the proceeds to pay qualified higher education expenses. You must have been at least 24 years old when the bonds were issued, and your modified adjusted gross income must fall below annually adjusted thresholds. The exclusion phases out at higher incomes and is not available to married taxpayers filing separately. You claim it using IRS Form 8815.
What Protects the Money Behind the Interest
Interest-bearing deposits at banks and credit unions carry federal insurance. The FDIC covers deposits at member banks up to $250,000 per depositor, per bank, for each ownership category.9FDIC. Understanding Deposit Insurance The NCUA provides the same $250,000 coverage at federally insured credit unions.10National Credit Union Administration. Share Insurance Coverage
Ownership categories include individual accounts, joint accounts, certain retirement accounts like IRAs, and trust accounts. A married couple could each hold an individual account and share a joint account at the same bank, with each separately insured up to $250,000, letting a household protect well above $250,000 at one institution. Bonds and other securities are not covered by FDIC or NCUA insurance; the protection applies to deposit products like savings accounts, CDs, and money market deposit accounts.