Interest income is periodic cash paid by borrowers to depositors or investors.
Interest is money paid by a bank to a depositor. Anyone who holds cash in a bank savings or checking account is lending that money to the bank.
The bank then makes money by lending it out to others for mortgages, car loans and business loans. The depositor is compensated for the use of his or money in the form of monthly interest payments.
Those regular cash payments are income. Because it’s income, the bank must report the payments to the Internal Revenue Service and to state tax collectors.
Investors, meanwhile, typically earn interest income by owning bonds.
Some bond interest, such as from municipal bonds, is tax exempt. Income from most other bonds is taxed.
The tax rate of your interest income is determined by your normal income tax bracket.
Income is income, no matter how you earn it. If you work at a job and get paid a salary, you expect to pay federal and state taxes at the end of the year.
Interest income from bank accounts and investments are not different. It’s still income.
Many retirees rely on interest income to pay their monthly bills. That might take the form of interest earned on a savings account, which is relatively low but very safe.
It might also take the form of certificate of deposit (CD) interest, which generally pays a higher rate than savings accounts.
The interest income on a CD is higher because the depositor agrees to lock up his or her cash for longer periods of time, often months or years. The longer you can leave the money in the CD, the higher the interest you will earn.
A bond pays interest based on a number of factors, including the length of the bond (known as maturity) and the amount of risk you take as an investor.
Bank accounts and CDs are insured by the federal government. A bond investment, however, can lose money. They typically also pay more interest income than savings accounts and CDs to offset the investment risk.
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