Savings accounts are offered by traditional banks, credit unions and online banks. They serve as a safe haven for your money and pay interest on your deposits. Savings accounts are also an ideal place to build your emergency fund in case you need extra cash on a rainy day.
This comprehensive guide explores the ins and outs of savings accounts. More specifically, it covers how they differ from checking accounts, key features, various types of savings accounts to choose from, benefits, interest rates and fees. You’ll also learn how to compare options and open a savings account with ease.
What is a Savings Account and How Does It Work?
A savings account is a type of deposit account held at a bank, credit union or other financial institution. It’s typically used to build an emergency cushion or save for a specific future goal, and your money earns interest until you withdraw it.
What is the Difference Between Using a Savings Account and a Checking Account?
A checking account is designed for everyday spending, while savings accounts are geared toward saving and growing money. Here’s a closer look at how the two vary:
Accessibility
- Savings account: counter cash withdrawals, ATM withdrawals (with ATM card)
- Checking account: counter cash withdrawals, debit card, checks, ATM withdrawals (with debit card)
Annual Percentage Yield
- Savings account: higher than checking accounts
- Checking account: low or none
Transactions
- Savings account: limited (often capped at six before fees apply)
- Checking account: frequent
Key Features of Savings Accounts
Below is a closer look at the key components of savings accounts:
- Interest rates: Savings accounts typically offer a modest interest rate, allowing your money to grow slowly over time.
- Safety: If your savings account is held at an FDIC-insured financial institution, deposits of up to $250,000 are backed. The same applies to funds at credit unions that are NCUA-insured.
- Accessibility: Withdrawal limits typically apply, but you can access your funds as needed.
- Minimum balance requirements: Some savings accounts require you to maintain a minimum balance, or you’ll incur a fee.
- Types of savings accounts: Not all savings accounts are the same—more on this in the next section.
- Online vs. traditional banks: Although savings accounts can be found at traditional banks and credit unions or online, you’ll often earn more in interest with the latter.
Types of Savings Accounts
Basic Savings Accounts
These accounts let you earn a small return on your money, and you can withdraw funds as needed (subject to limitations). Basic savings accounts often have low minimum balance requirements and are an ideal option for emergency funds or to save for short-term goals.
High-Yield Savings Accounts
High-yield savings accounts come with higher APYs than basic savings accounts. They’re ideal if you want to safely maximize your earnings without committing to a long-term investment account, like a CD, but they typically carry minimum balance requirements.
Online Savings Accounts
Online savings accounts are managed entirely through digital platforms. They generally come with more competitive rates and little or no fees, as they are less costly for financial institutions to manage.
Money Market Accounts
Money market accounts (MMAs) combine the features of savings and checking accounts. They offer competitive interest rates and provide easy access to funds through checks or debit cards, but they often come with higher minimum balance requirements and monthly transaction limits.
Certificates of Deposit
Certificates of deposit (CDs) offer a fixed return on your money if you agree to leave it in the account for a set period. They generally offer higher interest rates compared to regular savings accounts – the longer the term, the higher the rate. However, withdrawing the funds early could be costly.
Specialty Savings Accounts
Specialty savings accounts cater to specific needs. Common examples include student or kids savings accounts and senior savings accounts. There are also health savings accounts, which are tax-advantaged and used by individuals with high-deductible health plans to cover medical expenses.
What are the Benefits of a Savings Account?
There’s a lot to love about savings accounts.
Safety and Security
As previously mentioned, deposits are typically insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per account holder. This means your money is protected even if the bank fails.
A savings account also offers protection against theft and loss. Unlike keeping cash at home, your money in a savings account is safe from dangers like fire, burglary, or accidental mishaps.
Interest Earnings
Savings accounts allow your money to grow over time through interest earnings. The interest rate may not be very high, but it’s better than keeping money in a non-interest-bearing account. Even a modest annual percentage yield (APY) can help grow your savings over time.
Liquidity and Flexibility
Savings accounts provide easy access to your funds, making them highly liquid and flexible. You can typically withdraw money at any time without penalty (subject to restrictions for ATM withdrawals), which is helpful if you encounter a financial emergency or unexpected expense.
Financial Discipline
Making regular deposits helps you develop good savings habits. Plus, you’ll be one step closer to creating a fully funded emergency fund. Doing so prevents you from relying on credit cards or loans when life happens.
Savings Account Interest Rates
How Interest is Calculated
Interest on savings accounts is usually calculated based on your average daily balance. More specifically, your bank or credit union takes the balance in your account at the end of each day, adds these amounts for the month and divides them by the number of days in the month. The bank then applies the interest rate to this average.
Factors Affecting Interest Rates
When the Federal Reserve hikes or lowers interest rates, banks typically adjust their rates accordingly. Higher inflation rates can lead to increased interest rates, while special offers and competition among banks can also impact the rate you receive.
Compounding Frequency
Compounding frequency refers to how often interest is added to an account. It can be daily, monthly or annually.
Fees and Charges Associated with Savings Accounts
Monthly Maintenance Fees
Many banks charge a monthly maintenance fee for savings accounts. This fee depends on the financial institution, often falling between $1 and $12 per month. It may be waived if specific criteria are met.
Withdrawal Limitations and Excess Withdrawal Fees
Federal regulations typically limit withdrawals or transfers from savings accounts to six per month without incurring fees. Exceeding this limit may result in excess withdrawal fees ranging from $5 to $15 per transaction. Frequent violations of these limits could lead to your account being converted into a checking account.
Inactivity Fees
Banks can charge an inactivity fee if your savings account remains dormant for a certain period. It’s a good practice to make small deposits or withdrawals periodically to keep your account active and avoid this added cost or, in some instances, account closure.
How to Open a Savings Account
Choosing the Right Bank or Financial Institution
Start by deciding between a traditional bank, credit union or online bank. Consider important factors such as fees, interest rates and minimum balance requirements. Also, pay attention to customer reviews and ratings.
Required Documentation
Next, gather the documents you’ll need to open your account. Typically, you’ll need a copy of your driver’s license, ID or passport and proof of address. You’ll also be required to complete an application where you’ll disclose your date of birth, Social Security number and contact information.
Initial Deposit Requirements
Most banks and credit unions require an initial deposit to open a savings account. Make sure you have the funds ready and understand how you can make this deposit.
Comparing Savings Accounts
Comparing Interest Rates
The interest rate you get depends on the type of account and financial institution you select. Comparing these rates directly can help you determine which account will provide the most earning potential for your savings.
Understanding Terms and Conditions
Always read the terms and conditions of a savings account before opening it to avoid any surprises. These documents outline the rules and fees associated with the account you select.
Conclusion: Maximizing the Benefits of a Savings Account
To get the most out of a savings account, choose one with a high annual percentage yield (APY) to grow your money faster. Make regular deposits, preferably through automatic transfers, and keep your savings separate to avoid dipping into the funds.
