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Managing Your Money

How to Help Minimize Taxes on Your Savings Account Earnings

Learn how you can help minimize taxes on earnings by focusing on state and local tax advantages with savings account alternatives.

Articles by Eric Bronnenkant

By Eric Bronnenkant
Head of Tax, Betterment  |  Published: September 28, 2018

State income taxation is typically an after-thought for many people. Most people pay more in federal income tax than they do to the state, and so, they tend to forget the impact state taxes can have on how much money they keep each year. There are, for instance, some states, like New York, New Jersey, California, Maryland, and Connecticut, that do have significant income tax rates. In addition, some localities have an income tax; New York City is the most populous example of this.

Why bring your attention to state and local taxes? Today, we’ll review a key approach to minimizing taxes on your cash savings, and—surprise surprise—it’s all about that second tax return you probably file each year: your state and local income taxes.

The tax advantage we explain here is a fundamental insight for how Betterment’s Smart Saver serves as a partially tax-advantaged alternative to a savings account. Read on to learn how it works.

Taxes on Your Savings Account: A Quick Review

You may forget year-to-year that the interest you earn on your savings account is taxed. For all U.S. taxpayers, the interest you receive from your bank or credit union pays back to you is added to your other earnings (salary, wages, and capital gains) to total your gross income on a tax return. After accounting for deductions, this amount becomes your taxable income, which is the main input into how much you are taxed.

For states and localities with an income tax, the taxable income total has a few exceptions, one of which directly relates to your cash savings. States consider your bank account interest in your taxable income, but they do not consider interest on U.S. Treasury bonds to be taxable, due to federal law. Learn more about reporting government income on your state taxes.

Why is this important? Both U.S. Treasury bonds and bank products are often used as stable places to earn interest on extra cash. The difference in how states and localities tax each form of income, however, changes how much of those earnings you get to keep each year.

Using U.S. Treasury Bonds for Tax-Advantaged Cash Savings

Because states and localities cannot tax U.S. Treasury bonds (or any direct obligations of the U.S. government), it makes these bonds partially tax-advantaged, compared to other savings vehicles, like a savings account.

Put another way, U.S. Treasury Bonds, when purchased and managed in a smart way, can make for a tax-advantaged alternative to a conventional savings account, in which your money is entrusted to a bank, without tax advantages.

To make this comparison comprehensive, however, there are a few details to remember.

  1. For starters, savings accounts are designed to give you liquid access to your money. U.S. Treasury bonds are liquid but withdrawals from Betterment take approximately 4-5 business days.
  2. Interest rates vary broadly on savings accounts. So, before even considering the tax advantages of bonds, it’s worth considering the rate alone. Since the average bank’s savings account APY falls well below 1% currently, an improved rate alone may be a reason to consider an alternative. Conversely, you may be able to find a top savings account that compensates you enough to offset your potential state and local tax savings.
  3. Remember that the tax advantage of U.S. Treasury Bonds is only useful if you currently face state and local income taxes. If your state doesn’t have an income tax, then this tax advantage is moot for you.

Smart Saver, an account within Betterment we designed to leverage this tax advantage, is based on these above criteria.

Ready to explore Smart Saver?

Using Smart Saver as a Savings Account Alternative

We designed Smart Saver to give people access to the tax advantages of U.S. Treasury Bonds, while also pursuing a high yield. Smart Saver invests your money in a U.S. Short-Term Treasury Bond ETF, called SHV, as well as a U.S. Short-Term Investment Grade Bond ETF, called NEAR. The 80% of the portfolio represented by SHV is the tax-advantaged component.

While the NEAR portion of the portfolio helps Smart Saver seek a higher yield, and is subject to state and local taxes, it’s expected to yield a smaller portion of the total earnings. So, most earnings will be tax-advantaged.

To illustrate how the tax advantages of your Smart Saver earnings may work compared to a savings account, check out this table of all 50 states and major localities below:

State State/Local Tax Rate (Single, $150k Income) Hypothetical Earnings Before Tax on $10,000 in Smart Saver or a savings account with a 1.8% yield (net of fees) Potential State Taxes on $10,000 in Smart Saver (80% Invested in U.S. Treasury debt) Potential State Taxes on $10,000 in a 1.8% APY Savings Account
Alabama 5.00% $180.00 $2.05 $9.00
Alaska 0.00% $180.00 $0.00 $0.00
Arizona 4.24% $180.00 $1.74 $7.63
Arkansas 6.90% $180.00 $2.83 $12.42
California 9.30% $180.00 $3.81 $16.74
Colorado 4.63% $180.00 $1.90 $8.33
Connecticut 6.00% $180.00 $2.46 $10.80
Delaware 6.60% $180.00 $2.71 $11.88
Florida 0.00% $180.00 $0.00 $0.00
Georgia 6.00% $180.00 $2.46 $10.80
Hawaii 8.25% $180.00 $3.38 $14.85
Idaho 6.93% $180.00 $2.84 $12.47
Illinois 4.95% $180.00 $2.03 $8.91
Indiana (estimated 2.35% local) 5.58% $180.00 $2.29 $10.04
Iowa 8.98% $180.00 $3.68 $16.16
Kansas 5.70% $180.00 $2.34 $10.26
Kentucky 6.00% $180.00 $2.46 $10.80
Louisiana 6.00% $180.00 $2.46 $10.80
Maine 7.15% $180.00 $2.93 $12.87
Maryland (estimated 3.2% local) 8.70% $180.00 $3.57 $15.66
Massachusetts 5.10% $180.00 $2.09 $9.18
Michigan 4.25% $180.00 $1.74 $7.65
Minnesota 7.05% $180.00 $2.89 $12.69
Mississippi 5.00% $180.00 $2.05 $9.00
Missouri 6.00% $180.00 $2.46 $10.80
Montana 6.90% $180.00 $2.83 $12.42
Nebraska 5.50% $180.00 $2.26 $9.90
Nevada 0.00% $180.00 $0.00 $0.00
New Hampshire 5.00% $180.00 $2.05 $9.00
New Jersey 6.37% $180.00 $2.61 $11.47
New Mexico 4.90% $180.00 $2.01 $8.82
New York (non-NYC resident) 6.65% $180.00 $2.73 $11.97
New York (NYC resident) 10.53% $180.00 $4.32 $18.95
North Carolina 5.50% $180.00 $2.25 $9.90
North Dakota 2.27% $180.00 $0.93 $4.09
Ohio 3.87% $180.00 $1.59 $6.97
Oklahoma 5.00% $180.00 $2.05 $9.00
Oregon 9.00% $180.00 $3.69 $16.20
Pennsylvania 3.07% $180.00 $1.26 $5.53
Rhode Island 5.99% $180.00 $2.46 $10.78
South Carolina 7.00% $180.00 $2.87 $12.60
South Dakota 0.00% $180.00 $0.00 $0.00
Tennessee 4.00% $180.00 $1.64 $7.20
Texas 0.00% $180.00 $0.00 $0.00
Utah 5.00% $180.00 $2.05 $9.00
Vermont 7.80% $180.00 $3.20 $14.04
Virginia 5.75% $180.00 $2.36 $10.35
Washington 0.00% $180.00 $0.00 $0.00
West Virginia 6.50% $180.00 $2.67 $11.70
Wisconsin 6.27% $180.00 $2.57 $11.29
Wyoming 0.00% $180.00 $0.00 $0.00
D.C. 8.50% $180.00 $3.49 $15.30


This chart is for illustrative and demonstrative purposes only. The reported “State/Local Tax Rate” is based on the state tax rates reported by each U.S. State, and, where notated, the highest local tax rate, which we add to the state tax rate to form an estimate. The hypothetical earnings on $10,000 assume no withdrawals, deposits, or reinvestment of earnings.

In the case of “Potential State Taxes for Smart Saver”, the listed state and local income tax calculation is imposed on the estimated yield before deduction of Betterment’s 0.25% management fee (~2.05%), then adjusted for the fact that 80% of the hypothetical income is exempt from state and local income tax (the SHV portion of a Smart Saver portfolio). The remaining 20% of the hypothetical income is subject to state and local income tax (the NEAR portion of a Smart Saver portfolio).

“Potential State Taxes on a 1.8% APY Savings Account” assumes earnings are taxed at the listed “State/Local Tax Rate” for all earnings.

Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.

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