When you need a place to keep your money that you’ll use to pay bills or cover expenses, a checking account is an obvious choice. But when you want to set money aside for future needs and goals, a savings account can be the better option.
Savings accounts allow you to deposit money for safekeeping while also earning interest on your balance. You can open a savings-account at an FDIC-insured traditional bank or an NCUA-insured credit union, or with an FDIC-insured online bank. If you’re interested in opening a savings-account, there are a few important things to know about how they work.
What Is a Savings Account?
A savings account is a deposit account that’s designed to hold money you don’t need or plan to spend right away. This is different from a checking account, which may allow you to write checks or make purchases and ATM withdrawals using a debit card.
Savings accounts help you stash money away for specific purposes and goals. For example, you may open a savings-account to hold your emergency fund, or you could set up a down payment savings-account ahead of buying a home.
While savings accounts can offer convenient access to your money, there are limits to how often you can tap into one. Until very recently, Federal Reserve Board Regulation D has limited you to six withdrawal transactions per month, including:
- Overdraft transfers to a checking account
- Electronic funds transfers (EFTs)
- Automated clearing house (ACH) transfers
- Transfers made by phone, fax, computer or mobile device
- Wire transfers made by phone, fax, computer or mobile device
- Check or debit card transactions
In April 2020, the Fed issued a final interim rule, giving financial institutions the option of lifting the six-per-month withdrawal restriction. However, if you go over the six transaction limit, your bank still can charge an excess withdrawal fee. The good news is that some transactions, such as transfers made via ATM or a branch, don’t count against this limit.
How Do Savings Accounts Work?
Savings accounts aren’t overly complicated. You open a savings-account at a bank or credit union and deposit money into the account. The bank then pays you interest on your balance.
You can continue adding money to savings, usually through one or more of these methods, depending on the bank:
- Cash or check deposits at the ATM
- Cash or check deposits at a branch
- ACH transfers from a linked bank account
- Wire transfers from another bank account
- Mobile check deposit
- Direct deposit
The interest rate you earn, and the corresponding annual percentage yield, or APY, can vary from bank to bank and from account to account. The APY is the rate of interest earned on your savings when compounding interest is factored in.
So, assume you open a savings account with $1,000. You deposit $200 a month into your account and the bank pays an APY of 0.90%. After one year, your balance would be $3,419.84, $3,400 of which are your deposits and $19.84 of which is interest. The higher your APY, the more you deposit and the longer you save, the more your money can grow over time.
Benefits of Opening a Savings Account
There are several good reasons to keep money in a savings account, starting with being able to earn interest. As the previous calculation shows, savings-accounts allow you to increase your money without your having to do anything extra. Although this isn’t free money—you still have to pay taxes on interest earnings—it is money you can earn passively just by saving regularly.
Savings accounts also offer more liquidity and convenience than other ways to save. A certificate of deposit or CD, for example, is another option for saving for short- and long-term goals. And, compared to some savings-accounts, it’s possible to earn a better APY with a CD account.
But there’s a catch: CD accounts are time deposits, meaning that when you open one, you’re agreeing to leave your money in the CD for a set time period. While your money is in the CD, it earns interest, but you generally can’t access it without triggering a penalty before it matures. A savings account, on the other hand, would allow you up to six withdrawals per month without a penalty.
Savings accounts also are a safe way to set aside money for the future. While investing money is another way to help it grow, putting money into stocks or mutual funds can carry risk. Savings accounts, on the other hand, can offer a consistent rate of return without putting you at risk of losing money.
And, unlike investments, savings accounts can be FDIC or NCUA insured. This FDIC (or NCUA) insurance means that, even if your bank fails, your savings are protected up to certain limits ($250,000 per depositor, per account ownership category).
Types of Savings Accounts
There are different types of savings accounts you can open, depending on where you decide to bank and what your needs are. Here’s a brief look at how they compare.
Standard/Traditional Savings Accounts
Standard savings accounts are the most commonly offered savings option. You can find these at brick-and-mortar banks and credit unions.
With this type of account, you’re typically earning a lower APY. (The weekly national average savings interest rate, as reported by the FDIC, has been 0.05% APY since late August 2020.) You also may be subject to a monthly maintenance fee or minimum balance fee. These accounts are designed to be a basic savings option.
High-Yield Savings Accounts
High-yield savings accounts are just what they sound like—savings accounts that offer an above-average APY. You’re more likely to find high-yield savings-accounts at online banks, although traditional banks and credit unions also can offer them. In addition to offering higher yields, due to their lower overhead, online banks also may charge fewer fees for high-yield savings accounts.
Money Market Accounts
Money market accounts combine features of a savings account with features of a checking account. This means you can earn interest on your balance, and you also can write checks or make withdrawals and purchases using a debit card.
Money market accounts may offer better rates than standard savings accounts, although they are still subject to the six withdrawals per month rule. You might choose a money market account if you want to have even more convenient access to your savings.
Kids’ and Student Savings Accounts
Kids and students also can get in on the savings action with special children’s savings accounts designed just for them. These accounts usually have an age cutoff for saving; with student accounts, for example, you may not be able to open one if you’re 25 or older.
These accounts are designed to help children, teens and students learn how to get into a savings habit, can pay interest and may or may not charge fees. You’re more likely to find these accounts at traditional banks, versus online banks.
Specialized Savings Accounts
Some banks offer special savings accounts that are designed for just one purpose. So, for example, you might be able to open a savings-account just for Christmas savings or to save money for a down payment on a home.
These accounts aren’t as common as other savings options and they can sometimes come with restrictions. For instance, with a Christmas savings account, you may only be able to make a withdrawal once a year in November ahead of the holiday shopping season. A down payment account may offer a matching savings bonus, but only if you get your mortgage from the bank you opened the account with.
How To Open a Savings Account
A savings account can be helpful for saving money toward various financial goals, and it pays to do your research when opening one. Otherwise, you could end up with a savings-account mismatch.
When you’re ready to open a savings account, first think about which type of account may be most helpful. For example, either a standard or high-yield savings-account could be the right choice for an emergency fund. But, if you’re saving money to pay cash for a car, you might want to choose a money market account instead that would let you write a check for the purchase.
Also, consider how much money you have to save. Some banks may require you to have a few hundred or even a few thousand dollars to open a savings account. An online bank, on the other hand, may allow you to start saving with as little as $1.
Next, consider the fees and the APY you can earn with a savings account. Ideally, you should choose an account that has the highest APY with the lowest fees. The more fees you pay, the less of your interest earnings you get to keep. Also, check to see if the APY you can earn applies to all balances. Some banks have interest tiers based on your balance, meaning you have to save more money to get the highest APY.
Finally, think about whether you’d prefer to save money with an online bank versus a brick-and-mortar bank or credit union, as well as the different options you have for dipping into your savings when necessary. Online and mobile banking can make your money accessible, but you also may be interested in ATM access or being able to visit a branch. Looking at all the options can help you narrow down which savings account is right for you.