What Is a Savings Account?

Key Takeaways

What Is a Savings Account?

A savings account is a fundamental deposit account that allows you to deposit money and typically earn a small to moderate interest. These accounts are federally insured up to $250,000 per account owner, per financial institution, and per ownership category, either through the Federal Deposit Insurance Corp. (FDIC) for banks or the National Credit Union Administration (NCUA) for credit unions. The insurance offers a secure place to store your money while earning interest.

Savings accounts are available at both banks and credit unions. You don’t need a substantial amount of money to open one, and you’ll also have easy access to your funds, though there may be limits on the number of withdrawals you can make each month.

Why You Need a Savings Account

A savings account is an ideal place to store money for future use, separate from your day-to-day spending cash, as it provides safety, liquidity, and the potential to earn interest on your funds. These accounts are excellent for storing your emergency fund or saving for short-term goals like vacation or home repairs.

In addition to providing quick access to your cash when needed, savings accounts often offer higher interest rates than checking accounts. Some savings accounts may offer higher annual percentage yields (APYs) than money market accounts. While the average APY on savings accounts is around 0.57 percent, you can find high-yield savings accounts offering more than 5 percent.

Moreover, there are plenty of opportunities to open a savings account with minimal fees, making it easy to avoid maintenance fees by choosing a straightforward option.

How Does a Savings Account Work?

Opening a savings account is similar to opening a checking account online or in person. You must provide the bank or credit union with personal information and deposit money into the account.

Once your money is deposited, interest will start to be earned. Interest earned depends on factors such as your account’s interest rate, APY, the amount deposited, and how long the money remains.

Banks may compound interest daily, monthly, quarterly, or yearly. After each compounding period, the accrued interest is added to your account balance, and your new balance will start earning interest.

For instance, if you deposit $10,000 into an account with a 0.1 percent APY and interest is compounded annually, you’d earn about $10 in interest after a year. However, if you choose a high-yield savings account with a 4 percent APY, you’d earn approximately $400 in interest over the same period. The balance, whether $10,010 or $10,400, would start earning interest in the next period. A shorter compounding period will result in faster growth of your savings.

It’s important to note that savings account APYs are variable and can change based on the Federal Reserve’s interest rate decisions. While you can withdraw money from your savings account anytime, many institutions limit the number of withdrawals to six per month.

How to Maximize Earnings from a Savings Account

Although the average interest rate on savings accounts is low, there are several ways to increase your earnings:

• Consider Community and Online-Only Banks: Large brick-and-mortar banks generally don’t offer the same returns as smaller institutions. Online-only banks, including challenger or neobanks, often provide the best yields as they save on costs associated with physical branches and pass those savings on to customers.
• Get a Sign-Up Bonus: Some banks offer cash bonuses when you open a new savings account. These bonuses can be substantial, so it’s worth watching for the best bank account bonuses, especially if they come with competitive interest rates.
• Shop at Credit Unions: Credit unions, which are member-owned and not-for-profit, often provide better yields than other financial institutions, along with low fees.
• Leverage Compound Interest: Although savings accounts offer liquidity, your money will grow faster the longer you leave it untouched. A compound interest calculator can help you see how quickly small deposits increase.
• Avoid Fees: Some savings accounts with attractive rates have fees that can reduce your overall interest earnings. It’s best to find an account with minimal or no fees and avoid incurring unnecessary charges.

How to Open a Savings Account

Opening a savings account is straightforward if you’re prepared. Here’s a quick checklist to help you get started:

• Decide How to Apply: Choose whether to apply online, over the phone, in person, or by mail.
• Gather Identification: Have your Social Security or tax ID number ready and information from a government-issued ID like a driver’s license or passport.
• Provide Contact Information: Be prepared to share your details, including your name, phone number, address, email, and date of birth.
• Determine Account Type: Decide if you want to open an individual or joint account.
• Review Terms and Conditions: Carefully read all documentation about account fees, responsibilities, and how your interest is calculated.
• Submit Your Application: Send your application and wait for the bank to process it, which may take a few days.
• Make Your First Deposit: Deposit money into your new account, ensuring you meet any minimum deposit requirements set by the bank.

How Much Should You Keep in Your Savings Account?

The amount you should keep in a savings account depends on your financial goals. Financial advisors often recommend keeping three to six months’ worth of living expenses in your account for an emergency fund.

For example, if your monthly expenses, including mortgage, car payment, and food, total $3,000, you should save between $9,000 and $18,000 in your account.

If you’re saving for a specific goal, like a vacation, home purchase, or car, keep enough in your savings account to cover that expense.

Using a savings calculator can help you determine how long it will take to reach your savings goal based on your monthly contributions.

Savings Accounts: Advantages and Disadvantages

Advantages:

• Safety: Money in a savings account at an FDIC-insured bank or an NCUA-insured credit union is insured up to $250,000 per account owner, financial institution, and ownership category, ensuring your savings are secure.
• Growth: Savings accounts generally earn interest, so your money grows while stored in the account.
• Liquidity: Although savings accounts are separate from your daily spending accounts, they still allow up to six withdrawals or transfers per statement cycle.
• Organization: Keeping your savings separate from your spending money helps you track your progress, curb overspending, and better view your overall financial situation.

Disadvantages:

• Lower Yields Elsewhere: The main drawback is that savings account interest rates may be lower than those offered by other financial products, though these often come with higher risk.
• Accessibility Restrictions: Most institutions limit the number of withdrawals or transfers you can make from a savings account to six per statement cycle.
• Loss of Purchasing Power Over Time: If the yield on your savings account is lower than the inflation rate, your money will lose purchasing power over time.

Other Types of Deposit Products for Savers

Savings accounts aren’t the only federally insured options for stashing your money. Banks and credit unions offer other savings products that are low-risk, liquid, and interest-bearing:

• Money Market Accounts: These accounts may offer higher rates than savings accounts but often have higher minimum balance requirements. Like savings accounts, they limit withdrawals and transactions to six per billing cycle. Money market accounts also provide an ATM card and checks.
• Certificates of Deposit (CDs): CDs are time-deposit accounts that hold your money for a specified period. In return, they pay a guaranteed fixed yield, usually higher than savings or money market accounts. The trade-off is that your money is locked away for the term, ranging from a few months to several years. Withdrawing funds early can result in penalties that could consume both your interest earned and some of your principal.

Frequently Asked Questions (FAQs)

How Do You Open a Savings Account?

To open a savings account, visit a bank with your government-issued ID and any cash or checks you want to deposit. You must provide your address, contact information, and a Social Security or taxpayer identification number (TIN). Some banks may require you to open a checking account alongside a savings account, and there may be a minimum deposit requirement. You can also open a savings account online.

What Savings Account Will Earn You the Most Money?

Savings account rates frequently change, so comparing offerings from various banks and credit unions is worth comparing. As of June 2024, the best savings rates range from approximately 4.5% to 5.5%.

How Do You Close a Savings Account?

Most banks offer three methods to close an account: in person at a branch, by submitting a written cancellation request form, or over the phone. In each case, you may need to provide identifying information.

The Bottom Line

Savings accounts provide one of the simplest ways to earn interest on your money. They offer better interest rates than regular checking accounts while allowing easy access to your funds. However, the interest rates are lower than other investments and don’t keep pace with inflation. It’s advisable to consult a financial advisor to explore the best options for your money to achieve your financial goals.