What is a Savings Account?
A savings account is an account opened at a bank or credit union that is designed to hold your money.
Savings accounts usually pay a low interest rate, but they are considered safe for cash that is easily accessible for short-term needs.
Some savings accounts may pay higher interest rates than others. They may have limits on how often you can withdraw money.
In general, savings accounts offer flexibility that makes them great for building an emergency fund, saving for short-term goals like buying a car or going on a vacation, or earning a small amount of interest on your savings.
How Savings Accounts Work
Savings accounts and other deposit accounts are bank accounts that allow you to keep your money safe and earn interest at the same time.
For banks, these savings accounts are an important source of funds for lending. That’s why you can find savings accounts at any bank or credit union, whether it’s a brick-and-mortar branch or an online institution. Investment and brokerage firms also offer savings accounts.
Interest rates on savings accounts vary widely. With the exception of those that advertise a fixed rate for a certain period of time, banks and credit unions can change their rates at any time. In general, the more competitive the rate, the more likely it is to fluctuate.
Changes in the Federal Funds Rate can force banks to adjust deposit rates. Some institutions offer high-yield savings accounts that offer significantly higher interest rates with higher minimum deposit amounts. You should take the time to explore these.
Savings Account Rules
Some savings accounts require you to maintain a minimum balance to avoid monthly fees or to earn the highest interest rate. Some accounts have no minimum balance requirement.
It’s important to know your account’s rules to ensure that fees don’t reduce your interest earnings.
You can add or withdraw money to and from your savings account online, at a branch or ATM, by wire transfer, or by direct deposit. You can also usually arrange transfers over the phone.
Some banks limit the number of withdrawals you can make to six per month. If you exceed this limit, the bank may charge a fee, close your account, or change your checking account.
However, there is no limit to the amount you can withdraw. You can withdraw the entire amount in your account.
Interest earned on savings accounts is earned in the money market. It is taxable income, just like interest earned from a certificate of deposit (CD) or checking account.
Whenever you earn more than $10 in interest income, your bank or financial institution will send you a 1099-INT Form at tax time. The amount of tax you pay depends on your marginal tax rate.
Advantages of Savings Accounts Explained
- Easy to use
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- Opening a savings account with the same institution as your main checking account offers benefits such as convenience and efficiency.
- Because transfers between accounts within the same bank are usually instant, deposits or withdrawals from your checking account to your savings account are immediately effective.
- Can be linked to checking account
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- Linking your checking account to your savings account makes it easy to transfer excess cash from your checking account and earn interest immediately.
- Or you may want to transfer money from your savings account to cover a large checking account transaction.
- Withdraw balance at any time
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- Unlike certificates of deposit (CDs), you can withdraw your balance at any time without incurring large early withdrawal fees. The money in your savings account will be liquid for you to easily withdraw.
- Up to $250,000 is federally insured
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- Government protection against bank failures, provided by the Federal Deposit Insurance Corp. (FDIC), will keep your money safer than keeping it under your mattress or in your sock drawer.
Disadvantages of Savings Accounts Explained
- Pays less interest than other options
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- In exchange for the easy access and security that savings accounts offer, they don’t pay as much interest as other savings options.
- If your investment horizon is long enough, you can earn higher returns by investing in certificates of deposit (CDs) or Treasury bills, or by investing in stocks and bonds.
- Easy access can make withdrawals tempting
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- The ease of withdrawing money from your savings account can make it tempting to spend your savings.
- May require a minimum balance
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- Some savings accounts require you to maintain a minimum balance each month to avoid fees or to earn the highest interest rate.
How to Get the Most Out of a Savings Account
While most major banks offer low interest rates on their savings accounts, many banks and credit unions offer higher returns. In particular, online banks offer some of the highest savings account rates.
They have few or no physical branches, so they have fewer overhead costs, and as a result, they can offer higher and more competitive deposit rates.
The key is to start with the bank where you have your checking account and compare across banks. Even if your bank doesn’t offer competitive savings account rates, it can still give you a baseline to estimate how much more you could earn by opening a savings account elsewhere.
But when looking for the best rates, be aware of account features that can reduce or eliminate your potential earnings.
There are promotional savings accounts that only offer attractive rates for a short period of time. Some accounts limit the amount of balance you can maintain to earn the promotional rate, and any dollars above that maximum amount earn little to no interest. Worse still are savings accounts that include service fees that will eat into the interest you earn each month.
How to Open a Savings Account
To open a savings account, visit a bank or credit union branch, or open an account online at an institution that offers such services.
You will need to provide your name, address, telephone number, and photo identification. You will also need to provide your Social Security Number (SSN), as you will earn taxable interest on this account.
Some institutions will require you to make an initial minimum deposit when you open the account. Others will allow you to add funds to the account later after you open the account.
How much should you have in your savings account?
The amount you should keep in your savings account will depend on the goal of the account or how you use the account.
If you set up a savings account to automatically transfer excess money from your checking account, your balance will fluctuate regularly.
In contrast, if you are building a savings goal, your balance may start small but will gradually increase over time.
If your savings account is an emergency fund, aim to cover at least three to six months of living expenses. This will give you financial support in case of unexpected expenses like medical bills, car repairs, or job loss.
Depending on your financial situation, you may want to put part of your emergency fund in a regular savings account and invest the rest in higher-yielding investments.
Remember that your deposits are protected by FDIC insurance or NCUA insurance up to $250,000. This ensures that your funds are safe even if the bank or financial institution fails. For most users, this amount is more than enough to cover their deposits.
However, if you have more than $250,000 in deposits, you should consider separating your balance among more than one account holder or institution.
Savings Accounts for Children and Students
In the United States, you must be at least 18 years of age or older to open a savings account for yourself (although this requirement may vary by state).
However, there are many savings accounts designed specifically for minors. You can open a savings account for your child by providing a co-signer.
Student accounts usually have maximum age restrictions. For example, you cannot open a student account if you are over 25.
Since these accounts are designed to teach young adults how to use a bank account, they usually have lower fees and requirements, but they also tend to have lower interest rates.
Also Read: 7 Simple Steps to Create a Budget
The Bottom Line
Savings accounts offer one of the easiest ways to earn interest on your money. They offer higher interest rates than a regular checking account, while still making it easy to spend and withdraw money.
However, savings accounts pay much lower interest rates than other investments and do not keep pace with inflation.
You should consult with a financial advisor to review your options for investing your money to help you meet your financial goals.
