Why IRAs Help You Save on Taxes

Bank savings are incredibly thin these days, and taxes chew away at what little interest you earn.

You are probably stuck with the problem if you prize the safety offered by FDIC-insured bank accounts, but you can ease the tax burden a little by using a bank IRA instead of your classic savings account.

When most savers and investors think of individual retirement accounts, they think of mutual fund companies and brokerages. But banks offer them, too, and if you put money into a savings account or certificates of deposit  within an IRA, you can postpone the tax bill until you withdraw the money, rather than face it year after year.

Regardless of whether it’s earned from a taxable account or tax-deferred IRA, interest is taxed as ordinary income at rates from 10% to 35% for most people. The only difference is the timing: With a taxable account, tax is owed for the year the interest is earned, but with an IRA, tax is not due until the money is withdrawn.

Postponing the tax bill allows you to keep more money in the account, boosting the effects of compounding. No one’s getting rich on bank savings these days, because yields are so low, but it’s still a good practice to avoid tax bills for as long as you can.

Keep in mind, though, that you cannot take money out of an IRA until age 59 ½ without paying a 10% penalty on top of the tax on the account’s interest income. An IRA, therefore, makes no sense as a rainy day fund unless you are past that age. Nor would it make sense for any other savings you are likely to need before that age, such as for a down payment on a home.