What is a savings account and how does it work – Forbes Advisor

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 aside money for your future needs and goals, a savings account may be the best option.

Savings accounts allow you to deposit money in a safe place while earning interest on your balance. You can open a savings account at a traditional FDIC-insured bank or NCUA-insured credit union, or at 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 designed to hold money that you don’t need or plan to spend immediately. This is different from a checking account, which can allow you to write checks or make purchases and ATM withdrawals using a debit card.

Savings accounts help you save money for specific purposes and purposes. For example, you can open a savings account to hold your emergency fund, or you can set up a down payment savings account before buying a house.

Although savings accounts can provide convenient access to your money, there are limits to how often you can take advantage of them. Until very recently, the Federal Reserve Board’s Regulation D limited you to six withdrawal transactions per month, including:

• Overdraft transfers to a current account
• Electronic Fund Transfers (EFT)
• 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 released a final interim rule, giving financial institutions the option to lift the six-month withdrawal restriction. However, if you go over the six-transaction limit, your bank may still charge an excess withdrawal fee. The good news is that some transactions, such as transfers made through an ATM or branch, do not count against this limit.

How do savings accounts work?

Savings accounts are not too 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 to add money to savings, usually through one or more of these methods, depending on the bank:

• ATM cash or check deposits
• Cash or check deposits in branches
• ACH transfers from a linked bank account
• 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 account to account. The APY is the interest rate earned on your savings when compound interest is taken into account.

So let’s say you open a savings account with $1,000. You deposit $200 per month into your account and the bank pays an APY of 0.90%. After one year, your balance would be $3,419.84, including $3,400 in deposits and $19.84 in interest. The higher your APY, the longer 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 the ability to earn interest. As the previous calculation shows, savings accounts allow you to increase your money without you having to do anything more. While this isn’t free money – you still have to pay tax on the interest income – it’s 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 savings option for both short-term and long-term goals. And, compared to some savings accounts, it is possible to earn a better APY with a CD account.

But there’s a catch: CD accounts are term deposits, which means that when you open one, you commit to leaving your money on the CD for a set period of time. While your money is on the CD, it’s earning interest, but you usually can’t access it without triggering a penalty before it’s due. A savings account, on the other hand, would allow you up to six withdrawals per month without penalty.

Savings accounts are also a safe way to put money aside for the future. While investing money is another way to help it grow, investing in stocks or mutual funds can be risky. Savings accounts, on the other hand, can offer a consistent rate of return without exposing you to the 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 category of account ownership).

Types of savings accounts

There are different types of savings accounts you can open, depending on where you decide to bank and your needs. Here’s a quick look at how they compare.

Standard/Traditional Savings Accounts

Standard savings accounts are the most commonly offered savings option. You can find them at physical banks and credit unions.

With this type of account, you generally earn a lower APY. (The weekly average interest rate of national savings, as reported by the FDIC, has been 0.05% APY since end of August 2020.) You may also be subject to monthly maintenance fees or minimum balance fees. These accounts are designed to be a basic savings option.

High Yield Savings Accounts

High-yield savings accounts are exactly what they sound like: savings accounts that offer above-average APY. You’re most likely to find high-yield savings accounts at online banks, although traditional banks and credit unions may also offer them. In addition to offering higher yields, due to their lower overhead, online banks may also charge lower fees for high yield savings accounts.

Money market accounts

Money market accounts combine the features of a savings account with the features of a checking account. This means you can earn interest on your balance and you can also write checks or make withdrawals and purchases using a debit card.

Money market accounts can offer better rates than standard savings accounts, although they are still subject to the six withdrawals per month rule. You can choose a money market account if you want even more convenient access to your savings.

Savings accounts for children and students

Children and students can also get in on the savings action with special children’s savings accounts designed just for them. These accounts generally have an age limit for saving; with student accounts, for example, you may not be able to open one if you are 25 or older.

These accounts are designed to help children, teens and students get into the habit of saving, paying interest and charging fees or not. You are more likely to find these accounts at traditional banks than online banks.

Specialized savings accounts

Some banks offer special savings accounts designed for 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 house.

These accounts are not as common as other savings options, and they can sometimes come with restrictions. For example, with a Christmas savings account, you might only be able to withdraw once a year in November before the holiday shopping season. A down payment account may offer a matching savings bonus, but only if you get your mortgage from the bank where you opened the account.

How to open a savings account

A savings account can be useful for saving money toward various financial goals, and it pays to do your research when opening an account. Otherwise, you could end up with a savings account lag.

When you’re ready to open a savings account, first think about what type of account might be most useful to you. For example, a standard or high-yield savings account might 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 allow you to write a check for the purchase.

Also consider how much money you need 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, can get you started saving with as little as $1.

Next, consider the fees and 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 interest income you keep. Also check if the APY you can earn applies to all sales. Some banks have interest levels based on your balance, which means you need to save more money to get the highest APY.

Finally, think about whether you’d rather save money with an online bank than with a brick-and-mortar bank or credit union, and the different options you have for tapping into your savings if needed. . Online and mobile banking can make your money accessible, but you may also be interested in access to ATMs or the ability to visit a branch. Reviewing all the options can help you determine which savings account is right for you.