You’ve read all the advice and are ready to take the leap, but something holds you back from opening a high-yield savings account: taxes.
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Is it worth it? According to experts, absolutely yes. Here are some reasons a high-yield savings account is worth it despite the taxes.
It Offers High Returns With Low Risks
“There’s one main reason why it’s worth it to have a high-yield savings account despite the taxes: it offers high returns with low risks,” said Joe Chappius, tax expert at TaxClimate.com. “Simply put, the interest you earn might be taxable, but if you have enough cash in the account, the returns you get can still be quite significant compared to the taxes you’ll pay.
“Here’s an example: Suppose you have $20,000 in a high-yield savings account with an annual interest rate of 3%,” he explained. “Over a year, you would earn $600 in interest,” he said. “Now, let’s say your tax rate on this interest is 20%. This means you’d pay $120 in taxes on your $600 of interest you earned. So, after taxes, you’d still have $480 more than you started with.”
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It Offers Liquidity
According to Stephen Kates, CFP, principal financial analyst for Annuity.org, high-yield savings accounts are ideal for liquid savings, which can be accessible at a moment’s notice.
“If you may need some of your savings in under 18 months, but don’t necessarily know exactly when, you will have more peace of mind within a [high-yield savings account] since rates are similar to other options like CDs and Fed rate cuts are unlikely to create a huge difference in your return over that period of time,” he said. “The taxes owed on the interest is a small price to pay for safety and liquidity.”
He added that other savings options may reduce your liquidity, interest potential or principal protection, which are all huge negatives for an emergency fund.
“For instance, a CD, which is FDIC-insured, is not accessible without penalty except at maturity,” Kates explained. “Municipal bonds, which are more tax-efficient, have greater risk and less liquidity. If you invest in municipal bond funds, there is further risk of loss through daily fluctuations of the fund value and potential capital gains or losses if sold.”
It’s Ideal for an Emergency Fund
“Most importantly, it’s essential to have a savings account or emergency fund as you can use it to cover unexpected expenses or financial setbacks,” Chappius said. “This way, you’re not forced to dip into your investments or go into debt when you encounter difficulties in life. It’s a smart way to keep your finances stable and secure.”
Kates agreed. “An emergency fund is an essential and foundational stepping stone to financial success,” he said. “One of the key roles an emergency fund plays is as a buffer to unexpected or unknown expenses. Without one, a saver would be at risk of going into debt or selling longer-term investments to cover an unexpected expense.
“A robust emergency fund allows an investor to avoid short-term debt and maintain a consistent investment strategy undisturbed by inconvenient expenses or surprises.”
John F. Pace, CPA, tax manager for Pace & Associates CPAs, said it’s ideal for emergency funds.
“From my decades of experience working with estate and fiduciary tax returns, I can unequivocally state that having a high-yield savings account is beneficial despite the taxes paid on interest,” he said. “Access to cash in a high-yield savings account can be invaluable during emergency situations.”
Pace has seen this with his clients as well. “For instance, I once had a client who faced an immense medical emergency and was able to avoid high-interest loans solely due to the readily available funds in their high-yield savings account,” he said.
It’s Safe
“Safety is another significant advantage. High-yield savings accounts are FDIC-insured up to $250,000 per depositor, protecting your principal from market volatility,” Pace said. “This is particularly crucial for individuals who might not have the risk tolerance for investments in stocks or mutual funds. Safety nets like these help mitigate financial stress, even though the interest is taxable.”
It Promotes Disciplined Savings Habits
“Regular contributions to high-yield savings accounts also promote disciplined saving habits, which is fundamental to financial stability,” Pace said. “Structured savings can help individuals prepare for significant future expenses, like purchasing a home, funding education or retirement.”
Pace even advises his clients to be disciplined with their savings. “I’ve advised numerous clients to establish these habits, and it has consistently led to substantial, long-term financial security,” he said. “Even with tax liabilities on interest, the benefits of liquidity, security and disciplined savings far outweigh the costs.”
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This article originally appeared on GOBankingRates.com: 5 Reasons a High-Yield Savings Account Is Worth It Despite the Taxes You’ll Pay