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Fed Meeting Preview and Deposit Rate Forecast - March 15, 2023Beneficial Tax Feature of Ally Bank’s 11-Month No Penalty CD
If you have a sizable amount in your Ally Bank Online Savings Account and you want to keep it liquid, opening one or more 11-month No Penalty CDs with some of this money is an easy way to earn more interest. If the Online Savings Account rate goes down this year, the No Penalty CD will provide an even larger interest rate premium. If the Online Savings Account rate goes up and exceeds the No Penalty CD rate, you can just close the No Penalty CD. Ally Bank makes it very easy and quick to close a No Penalty CD and transfer the money into your Ally Online Savings Account. I consider the No Penalty CD a savings account rate booster rather than a CD.
| APY | MIN | MAX | INSTITUTION | PRODUCT | DETAILS |
|---|---|---|---|---|---|
| 4.75% | - | - | Ally Bank | 11 Month No Penalty CD | |
| 3.60% | - | - | Ally Bank | Online Savings Account |
Shifting Taxable Income Into the Next Tax Year
There’s another reason to consider the Ally 11-month No Penalty CD besides to earn more interest. It allows you to shift taxable income into the next tax year. This was recently discussed in this DA Forum post.
For CDs with terms of 12 months or less, Ally Bank will credit interest earned at maturity, unless you choose another interest payment option (i.e. monthly or quarterly). If you open the 11-month No Penalty CD after January and you choose the default option of letting Ally credit interest earned at maturity, no interest will be earned for the current tax year. Thus, no interest from the No Penalty CD will be included on the 1099-INT that you'll receive next January. If you just keep the money in the Online Savings Account rather than using it to fund a No Penalty CD, interest will be credited each month. Thus, this savings account interest will be listed on the 1099-INT that you’ll receive next January.
IRS Rules on CD Interest
The IRS rules on CD interest are detailed in IRS Publication 550. The following paragraph is from the section on “Interest Income” in Chapter 1:
Certificates of deposit and other deferred interest accounts. If you buy a certificate of deposit or open a deferred interest account, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.
I first noted this paragraph in my 2011 post on CD interest and taxes. When I reread the above excerpt from Publication 550, I was concerned about the following sentence and how this relates to the No Penalty CD:
You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty.
Are you “entitled to receive” interest from your No Penalty CD “without paying a substantial penalty”? Obviously, you’re entitled to close the No Penalty CD after six days of account funding without a penalty. At that time, you will receive the interest. However, you’re not entitled to receive interest if you do not close the No Penalty CD. Thus, if your No Penalty CD is set up so that interest is only paid at maturity and you keep the CD opened, you neither receive the interest nor are you entitled to receive the interest.
Ally’s 1099-INT
The above interpretation must be how Ally is interpreting this IRS rule since Ally is not including uncredited interest on 11-month No Penalty CDs in their 1099-INTs. I can confirm that on my 1099-INT. I opened an Ally No Penalty CD last August with interest to be credited at maturity. My 2019 1099-INT from Ally did not include any interest from this No Penalty CD.
When Tax Shifting Won’t Work
Of course, this shifting of taxable income into the next year won’t work if you choose an early closure of the No Penalty CD during the current tax year. You won’t lose any accrued interest, but all of that interest will be credited at the closure of the CD.
Also, this tax shifting may not work at other online banks that offer no-penalty CDs. I’ve reviewed the disclosures of several of these online banks, and all specify that interest earned will be credited monthly on their CDs.
Tax Shifting with Other Ally CDs
| APY | MIN | MAX | INSTITUTION | PRODUCT | DETAILS |
|---|---|---|---|---|---|
| 4.50% | - | - | Ally Bank | 12 Month High Yield CD | |
| 4.15% | - | - | Ally Bank | 9 Month High Yield CD | |
| 3.40% | - | - | Ally Bank | 6 Month High Yield CD | |
| 2.00% | - | - | Ally Bank | 3 Month High Yield CD |
This tax shifting also works with Ally’s 12-, 9-, 6- and 3-month High Yield CDs. The 12-month CD currently offers a rate that’s 10 bps higher than the top-tier rate of the 11-month No Penalty CD. So if you’re not concerned about liquidity, you may choose the 12-month over the 11-month. Don’t forget that the early withdrawal penalty on Ally’s CDs with terms of 24 months and under is only 60 days of interest.
I don’t see any reason to choose Ally’s 3-, 6- or 9-month CDs. All have a history of rates that have been much lower than the Online Savings Account rates. There is one reason why you may want the 3-month CD. By having a CD ladder of 3-month CDs, it makes it easy to take advantage of Ally’s 0.05% Loyalty Reward. This strategy is detailed in this DA Forum post.
This article contains general tax information and should not be considered tax advice. If you have a question about your taxes, and what should be reported on them, it is a good idea to consult a tax professional who can help you navigate the rules.
For federal income tax purposes, the doctrine of constructive receipt is used to determine when a cash-basis taxpayer has received gross income. A taxpayer is subject to tax in the current year if he or she has unfettered control in determining when items of income will or should be paid. Unlike actual receipt, constructive receipt does not require physical possession of the item of income in question.
I'm not disagreeing with Ken or with Ally Bank. Am only pointing out that, as with so many other tax rules, this one can be annoyingly vague. Sometimes you wonder if they're not doing it on purpose, just to harass us poor taxpayers and to make our lives as miserable as possible.
However, I don't think the CD holder is "entitled to receive" it over the course of the year on the basis that they could have chosen monthly or quarterly interest. That choice is BEFORE the CD is actually open, during the application for the CD.
Once chosen, you are locked into that condition, that's the terms of the CD you opened. That you could have opened a different CD makes no difference, all that matters is what you did open. You have no "unfettered control," you are now locked into the CD contract.
I agree with Ken's conclusion that just because you could close the CD without penalty and get the accused interest at that time does not mean you have "unfettered entitlement" to it at that time. I would think that having to give up the rest of the year of interest in order to collect that accrued so far certainly "fetters" your control and entitlement. Your unfettered entitlement to it would be only at the end of the term, as contracted.
Thus prolonging the new atmosphere I have experienced here since the evident change that has occurred at Deposit Accounts
As the articles mentions, many if not most other FIs do not choose this option, and instead simply pay interest monthly or quarterly. In those situations, you'll receive a 1099 for that interest when it was paid, and that's that. An example would be Marcus (Goldman-Sachs), which pays interest on No-Penalty CDs monthly. So, no shifting is possible there.
Note also that CDs with terms under 1 year but which are NOT No-Penalty CDs fall into the same category - the IRS says they can pay all the interest at the end if they so choose. An example would be the Keesler CU 7-month 5% CD offered in Fall 2018.
Finally, the intent of "tax-shifting" income into the future is not only to delay taxes for several to many months and thus save a bit on the "float" (which is frankly minimal these days, considering the low rates). Depending on one's personal circumstances, it may be advantageous to "place" income into certain years and avoid other years, because in those other years a person may experience unavoidable taxable income that cannot be shifted. Thus, folks might want to minimize any other income in those years that they can.
An entire year of interest might make the difference, as compared to just a partial year's worth spread over two years. Just a note to consider before choosing how you prefer the payment.
But this just makes the choice of taking it monthly, quarterly or annually a very good option. Most banks that deal in a single annual posting of interest do not give a choice.
It is annoying to cross a tax bracket boundary. But it can be far more consequential, in terms of cost, to cross an IRMAA boundary. I've done it. It was an experience memorable for its confiscation of my resources. Whoever dreamed up the IRMAA needs to be took out behind the shed and horsewhipped to within an inch of his life.
Likewise,
IRMAA is an acronym for Medicare's income-related monthly adjustment amount. This is a higher premium charged by Medicare Part B and Medicare Part D to individuals with higher incomes.
Seems like a pretty low income amount to have to pay that IRMMA considering how much people make these days. $86,000 a year is the amount teachers get (or more) and complain about how low paid they are. And that figure is before you take your personal exemption and includes non-taxable income, whereas the tax tier for higher tax rate is after your personal exemption and does not include non-taxable income.
Also, and amounts you made in capital gains 20 years ago but are only cashing in this year, that is "income taxable this year," not current income earned this year. That IRMMA figure should not include long term income, such as income from 20 years ago that you simply are paying the tax on now, such as money you are taking out of a mutual fund.
No one should have to pay more for Medicare than anyone else. You get the same Medicare no matter what you pay, it's the same product. And why should you have to pay more because you were prudent enough to save your money and now want to cash some of it in and enjoy the fruit of your hard work and self discipline?
Socialism punishes hard work, self-discipline and prudent management of your money, exactly the kind of traits the country needs more of not less.
According to the Social Security Administration, the Medicare Modernization Act established:
"an income-related reduction in Part B premium subsidies effective January 2007. Currently, the premium paid by a Part B beneficiary covers approximately 25% of the per-capita cost of Part B; the balance is subsidized by the Federal government. Section 1839(i) provides that individuals with modified adjusted gross income (MAGI) in excess of a threshold amount shall receive a lower premium subsidy."
The reduction of subsidies for higher-income people resulted in their paying the adjustment, in addition to the standard premium.
Scroll down to "Medicare Part B System" at https://www.ssa.gov/privacy/pia/Medicare%20Modernization%20Act%20(MMA)%20FY07.htm
IRMAA has two parts: The part that pertains to Medicare Part B, which was instituted pursuant to the "Medicare Modernization Act" of 2003 and the part that pertains to Medicare Part D which was instituted pursuant to the "Affordable Care Act" and signed into law in 2011 by President Obama.
The IRMAA should be repealed.
But beyond that, it is the structure of the IRMAA which is so threatening and concerning. You can, for the sake of just a single extra dollar of income, pay a thousand dollars more in (what amounts to a) tax. This is wildly unfair, and is nothing akin to the way our income tax works.
For persons unfamiliar in advance, encountering the IRMAA for the first time is like stepping off a cliff.
Having said that I think it unlikely that a bank the size of Ally Bank would use this practice if it was not in compliance with IRS regulations.
With Ally's 11 month NPCD I don't think there is any question that the depositor is in fact in "constructive receipt" of the interest accrued to the end of the first year for a CD that spans two tax years since he has control over when he closes the CD and is paid the accrued interest. But I assume Ally must use an exception to this rule and that it properly reports all interest on their 1099s in the year of maturity if the CD is held to maturity. Presumably the exception also applies to the depositor since I also think it unlikely Ally would contribute to putting its depositors at risk of underpaying their taxes.