What is resident withholding tax on a savings account?

It can be hard work to build your savings over time, and earning interest can help them grow that much faster. But you could lose a chunk of that interest to withholding tax by overlooking one simple step.

Savings accounts, transaction accounts and term deposits play a central role in the finances of many Australians – and collectively we have nearly $1.5 trillion sitting in them. If you’re thinking of opening a new savings account, it’s important to let the bank know your tax file number (TFN). You don’t have to provide your TFN, but if you choose not to, you could pay withholding tax on your interest earnings.

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To see how this works, let’s answer some FAQs and look at what you can do to avoid paying withholding tax on the interest you earn on your savings.

Do you pay tax on interest from a savings account?

The Australian Taxation Office (ATO) makes it clear that interest earned on bank accounts is assessable income. This means it needs to be reported in your income tax return each year.

Your account statements from your bank will set out how much you have earned in interest for the financial year. And it’s important to get the total right. Banks and other financial institutions report interest earned by account holders directly to the ATO, which then matches these details with the interest you declare in your tax return. If there’s a discrepancy, the ATO says it does adjust tax returns and you could face penalty charges.

There is an upside to this automatic reporting system. If you use the ATO’s online myTax system to complete your tax return, any interest earned on savings accounts can be pre-filled in your return, so you can be confident the figure is correct.

What is withholding tax?

Withholding tax, also known as resident withholding tax if you’re an Australian resident for tax purposes, is different to the tax you would normally pay on interest from savings accounts.

When you report interest income in your tax return, it is added to your other income including wages and salary. After allowing for any deductions you may claim, income tax is calculated using Australia’s marginal tax rate system then applied to your total taxable income.

As a guide for the 2021/22 or 2022/23 financial years, if you earn between $45,000 and $120,000, the marginal tax rate for each dollar over $45,000 is 32.5%, plus the Medicare levy which is 2% of your taxable income. So you could pay tax of up to 34.5% (including the Medicare Levy) on interest earnings.

In contrast, resident withholding tax deducted from your account doesn’t consider your personal marginal tax rate. Remember, withholding tax on savings accounts usually only applies if you don’t let your bank know your TFN or provide a TFN exemption. If the bank does not have details of your TFN and hasn’t received a valid TFN exemption, it is required by law to withhold tax on any interest you receive at the highest marginal tax rate.

As at July 2022, the top marginal tax rate (excluding the Medicare levy) is 45%. This means you could lose almost half your interest earnings to resident withholding tax, which the bank will automatically deduct from your account and forward to the ATO.

On the plus side, the ATO says you can claim a tax credit for any withholding tax when you lodge your tax return. However, in the meantime you could be missing out on the benefit of compounding returns on your interest earnings.

The simple solution to avoid paying withholding tax on savings accounts is simply to let your bank know your TFN when you open an account or shortly thereafter.

Which savings accounts are affected by withholding tax?

According to the ATO, withholding tax can apply to a range of investments, including any type of bank, building society or credit union account or investment that pays interest. This includes savings accounts, interest-bearing cheque accounts and fixed term deposits.

What if I have a joint savings account?

The ATO says that if two or more people hold a savings account in joint names, at least two account holders must provide a TFN to the bank or claim a TFN exemption.

Does withholding tax apply to foreign residents?

The ATO explains that if you are a foreign resident, your Australian bank will automatically withhold tax on any interest earned on savings accounts.

The rate of tax withheld depends on whether you let the bank know your overseas address. If you provide an address, withholding tax works out at 10%. Without details of your overseas address, tax is withheld at 47%.

Are there situations when withholding tax doesn’t apply?

You will need to provide a TFN to avoid having tax withheld if your savings account has earned more than $120 in interest in a financial year. The ATO suggests this threshold may be lower if you didn’t hold the account for the whole financial year.

Under-16s who earn $420 or more in interest annually will have tax withheld by their bank if there is no TFN linked to their account, provided they’ve given their date of birth to their bank. If the account is held by both of the child’s parents, either parent can quote their own TFN.

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