What is a savings account and how it works – Forbes Advisor
Editorial Note: We earn a commission on partner links on Forbes Advisor. Commissions do not affect the opinions or ratings of our editors.
When you need a place to keep your money that you will use to pay bills or cover expenses, a checking account is the obvious choice. But when you want to put money aside for your future needs and goals, a savings account may be the best option.
Savings accounts allow you to put money in a safe place while earning interest on your balance. You can open a savings account with a traditional FDIC-insured bank or NCUA-insured credit union, or with an FDIC-insured online bank. If you want to open 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 right away. This is different from a checking account, which can allow you to issue checks or make ATM purchases and withdrawals using a debit card.
Savings accounts help you put money aside for specific purposes and purposes. For example, you can open a savings account to hold your emergency fund, or you can create a down payment savings account before buying a home.
While savings accounts can provide convenient access to your money, there are limits to how often you can use one. Until recently, Federal Reserve Regulation D limited you to six withdrawal transactions per month, including:
- Overdraft transfers to a current account
- Electronic Funds Transfers (EFT)
- Automated clearing house (ACH) transfers
- Transfers made by phone, fax, computer or mobile device
- Bank 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 to lift the six-per-month withdrawal restriction. However, if you exceed the limit of six transactions, 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 aren’t 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 your savings, usually by one or more of these methods, depending on the bank:
- Cash or check deposits at an ATM
- Cash or check deposits in branch
- ACH transfers from a linked bank account
- Bank transfers from another bank account
- Mobile check deposit
- Direct deposit
The interest rate you earn and the corresponding annual percentage return, 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 factored in.
So, suppose 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, of which $ 3,400 is your deposits and $ 19.84 is 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 being able 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 is not free money (you still have to pay taxes on interest income), it is money you can earn passively just by saving regularly.
Savings accounts also offer more liquidity and convenience than other means of saving. 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 is possible to earn better APY with a CD account.
But there’s a catch: CD accounts are term deposits, which means that when you open one, you agree to leave your money on the CD for a set period of time. As long as your money is on the CD, it earns interest, but you usually can’t access it without triggering a penalty before it expires. 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 save money for the future. While investing money is another way to help it grow, investing money in stocks or mutual funds can come with risk. Savings accounts, on the other hand, can offer a constant 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 in the event of your bank’s failure, your savings are protected up to certain limits ($ 250,000 per depositor, per category of account holder).
Types of savings accounts
There are different types of savings accounts that you can open, depending on where you decide to go with the bank and your needs. Here’s a quick look at their comparison.
Standard / traditional savings accounts
Standard savings accounts are the most commonly offered savings option. You can find them at traditional banks and credit unions.
With this type of account, you usually earn a lower APY. (The average weekly national savings interest rate, as reported by the FDIC, is 0.05% APY as of the end of August 2020.) You may also be subject to monthly maintenance fees or maintenance fees. minimum balance. 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 an above-average APY. You are more likely to find high yield savings accounts at online banks, although traditional banks and credit unions may offer these as well. In addition to offering higher returns, due to their lower overhead costs, 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 that 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 may 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 participate in the savings action with savings accounts specially designed for them. These accounts generally have an age limit for savings; with student accounts, for example, you might 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 save, may pay interest, and may or may not charge fees. You are more likely to find these accounts at traditional banks than at online banks.
Specialized savings accounts
Some banks offer special savings accounts designed for a single 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 can sometimes have restrictions. For example, with a Christmas savings account, you might only be able to make a withdrawal once a year in November before the holiday shopping season. A down payment account can 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 useful for saving money for a variety of financial goals, and it’s worth doing your research before opening one. Otherwise, you could end up with a savings account mismatch.
When you’re ready to open a savings account, first think about what type of account might be most useful. For example, a standard or high yield savings account might be the right choice for an emergency fund. But, if you’re saving the money to pay for a car in cash, 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 have to save. Some banks may require you to have a few hundred or even a few thousand dollars to open a savings account. Online banking, on the other hand, can get you started 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 you keep your interest income. Also check if the APY you can earn applies to all sales. Some banks have interest levels based on your balance, which means you have to save more money to get the highest APY.
Finally, ask yourself if you’d rather save money with an online bank rather than a traditional bank or a 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 accessing ATMs or being able to visit a branch. Reviewing all of the options can help you determine which savings account is right for you.