Interest Rates, Inflation, and Your Taxes

Key Takeaways:

• The Federal Reserve has cut target interest rates to 3.75% – 4.00%, resulting in cheaper borrowing but less tax deductible interest
• Lower interest rates may decrease mortgage and student loan interest deductions, but you’ll save money on borrowing costs
• IRS inflation adjustments for tax year 2025 mean higher tax deductions and more generous tax bracket thresholds

In late October, the Federal Reserve announced interest rates will be cut down to 3.75% – 4.00%. If you’re wondering how this change affects your wallet, your savings, and your taxes, you’re in the right place. Here’s what these cooling interest rates mean for your money and what to expect when you file your taxes for tax year 2025.

The Fed and Interest Rates: What Happened and Why It’s Important

Beginning in March 2022, the U.S. Federal Reserve (Fed) raised interest rates 11 times in a row to combat high inflation. But the tide turned in September 2024, when the Fed began lowering rates as inflation cooled. The most recent cut, announced in late October, reduced the target federal funds rate by a quarter of a point (0.25 percent), to 3.75% – 4.00%.

This move matters because the Fed’s interest rate decisions affect many aspects of your financial life, from your mortgage payment to your credit card interest to how much you earn on savings accounts.

What lower rates mean for you:

• Borrowing gets cheaper. Interest on mortgages, auto loans, and credit cards tied to prime rates may go down, enabling you to keep more money in your pocket each month.
• Student loans cost less. Private student loans are tied to Fed rates, too, so you may see lower interest rates and reduced monthly payments for these loans.
• Savings interest rates drop. On the other side of the equation, the rate that banks pay you for funds held in high-yield savings accounts and CDs is also  connected to the Fed rates, so these payouts may get smaller.

IRS Inflation Adjustments for Tax Year 2025

Why it matters

Even while interest rates drop, the IRS continues making inflation adjustments that affect your 2025 tax return. These changes are designed to help protect you from “bracket creep,” which is when you move into a higher tax bracket than you were in the previous year even though your income didn’t grow as much as the rate of inflation.

Here are some of the key adjustments the IRS has made for tax year 2025:

Standard deduction increases

The standard deduction increased for tax year 2025:

• Single filers: $15,000 (up from $14,600 in tax year 2024)
• Married filing jointly: $30,000 (up from $29,200)
• Head of household: $22,500 (up from $21,900)

These adjustments automatically reduce your taxable income, potentially lowering your overall tax bill or increasing your refund.

Tax brackets shift upward

Income thresholds for each tax bracket increase for tax year 2025, meaning you can earn more income before jumping to the next tax rate. For example, in 2025, the 24% bracket applies only to taxable income over $103,350 for single filers. In 2024, the 22% threshold was just $100,525 for single filers. This change means more income is taxed at the lower 22% rate.

Earned Income Tax Credit (EITC) expansion

The Earned Income Tax Credit (EITC) provides significant relief for low-to-moderate-income earners. The maximum Earned Income Tax Credit for tax year 2025 increases to $8,046 for qualifying families with three or more children. This credit directly reduces your tax bill dollar-for-dollar and can result in a refund if it exceeds what you owe.

Other Benefits

Retirement contribution limits

Although retirement contribution limits increased  for tax year 2024, limits remain the same in tax year 2025:

• 401(k) plans: $23,500 ($31,000 if you’re 50 or older)
• Traditional and Roth IRAs: $7,000 ($8,000 if you’re 50 or older)

These tax-advantaged accounts serve as excellent opportunities to boost your retirement savings and reduce taxable income.

Health savings accounts (HSAs) and Flexible Spending Accounts (FSAs)

Annual contribution limits for HSAs and FSAs increased slightly for tax year 2025.

• HSA contribution limits: $4,300 for individual coverage, $8,550 for family coverage (an additional $1,000 if you’re 55 or older)
• FSA contribution limit: $3,300

By contributing to these accounts, you set aside pre-tax dollars for healthcare and dependent care costs, reducing your taxable income while building a financial cushion for eligible expenses.

Smart Moves to Make Right Now

Refinance strategically

With interest rates dropping, refinancing your mortgage or student loans could save you thousands. Just make sure to run the numbers or seek guidance from a financial planning professional to make sure refinancing makes sense for your situation.

Maximize your deductions

Track deductible expenses throughout the year to ensure you’re not paying more on your taxes than you have to. Expenses such as medical costs, charitable donations, student loan interest payments, and mortgage interest lower your taxable income. Use apps and tools to track the costs and donations throughout the year to make tax time easier. Staying organized can save you a lot of stress and money when filing your taxes.

Boost retirement savings

Higher contribution limits for tax year 2025 mean you can shield more of your income from taxes. Along with reducing your current tax burden, even small increases to your 401(k) contributions can add up significantly over time.

Don’t leave money on the table

Tax credits like the EITC, Child Tax Credit, and education credits enable you to save more of your money, so make sure you’re claiming everything you qualify for.

Take advantage of high-yield savings (while you can)

Interest rates on savings accounts are still relatively strong, though they’re declining. If you have an emergency fund or short-term savings goals, high-yield accounts still beat traditional savings accounts considerably.

Review your withholding

Major life changes, such as getting married, having a baby, or starting a new side hustle, can affect your tax withholding strategy. Too little withheld from your paycheck means a bigger tax bill in April; too much withheld means you’re giving the IRS an interest-free loan.

Watch for tax law changes

Overall, the Federal Reserve’s latest interest rate cut is a good thing for your finances. Lower borrowing costs help your budget now and IRS inflation adjustments help protect you from bracket creep at tax filing time.

However, it’s important to stay proactive: maximize your deductions and contributions, refinance if the math works, and keep careful records throughout the year. These small steps can add up to significant tax savings and better financial health overall.

And when tax season arrives, TurboTax can guide you through every deduction and credit you’re eligible for. Or, hand everything over to a TurboTax Experts who can handle your taxes from start to finish.