Instead of keeping all of your money in an easy-to-withdraw checking account, the smart thing to do is to spread the extra money around in a savings account.
There are some restrictions, but you have the opportunity to earn interest on the money within the account. That’s why it’s better to keep your cash reserves in this type of account than to simply keep it in your checking account.
When deciding on your savings account, you have three different types to choose from. We’ll discuss these in more detail, as well as other factors you should consider during the selection process.
You’ll also learn more about how interest is generated and how to open a savings account online or at a brick-and-mortar bank. By the time you’re done reading this article, you’ll have a strong understanding of how savings accounts work and how you can use them to manage your money.
How does a savings account work?
To open a savings account, you usually need to go to a bank or credit union and fill out an application. You may need to provide proof of identity and proof of income. You may also need a minimum deposit to open an account.
Once you open an account, you can deposit money and earn interest on the balance. Many banks and credit unions offer online and mobile banking. This makes it easy to manage your account and make transactions from anywhere.
What are the benefits of a savings account?
There are several benefits to opening a savings account:
- Safety: Savings accounts are insured by the FDIC, which means your money is protected up to $250,000 if the bank fails.
- Convenience: You can easily withdraw money through ATMs, online banking or at a branch.
- Earnings: While savings accounts may have lower interest rates than other types of investments, they can still help you earn a small amount of money from your balance over time.
- Discipline: Having a savings account encourages you to save money on a regular basis, thus helping you to develop good financial habits.
How do I find the best savings account?
There are several factors to consider when shopping for a savings account, including:
Interest rate: Find a savings account with a competitive interest rate to maximize your income.
Minimum balance requirements: Some savings accounts may require you to maintain a minimum balance to avoid fees or earn the highest interest rate.
Fees: Be sure to check any fees associated with the account, such as monthly maintenance fees or ATM fees, and choose the account with the lowest fees.
Accessibility: Consider how easy it is to withdraw money, such as through an ATM or online banking.
Customer service: If you have any questions about your account, find a bank or credit union with good customer service.
How does interest accrue in a savings account?
Interest on a savings account is not once a year; instead, it is compounded over multiple intervals. The exact frequency depends on the specific account you choose. Assuming all other characteristics are equal, the best option is daily compounding.
Other options include monthly or quarterly compounding. So how does compound interest actually work? Your account earns interest at regular intervals.
Annual vs. Daily Compounding Rate
Let’s say you open a $5,000 savings account with an interest rate of 1%. If your interest is only compounded annually (once a year), you’ll only earn $5 at the end of the year.
However, when the interest on the same account increases every day, you start making more money. Your 1% interest is divided into each day of the year, which technically equals 1/365th of a percentage point per day.
In this case, over the course of a year, it becomes the difference between $50 compounded annually and $50.25 compounded daily. This difference may seem ridiculous, but over time, the change really adds up.
Adding More Money & Rising Interest Rates
This is especially true when considering two variables. First, you will continue to deposit money into your savings account. By doing so, you will continue to create a snowball effect where a small amount of additional interest will accumulate into a large amount of interest over time.
Another variable is that interest rates will rise over time. While earning 1% interest is rare these days, savings account rates have been much higher historically.
As time goes on, the economy is expected to continue to strengthen and the benefits of compounding interest will grow. As with most things, patience is an important part of your financial longevity.
Are there any restrictions on a savings account?
Yes, most savings accounts have restrictions. Some apply to all accounts, while others depend on the specific account you choose.
In general, the federal government imposes limits on the number of transfers or withdrawals you can make each month, especially those that are considered “convenience” transfers or withdrawals. This includes any type of transfer, whether it’s online or via check or debit card.
ATM Withdrawal Limits
Withdrawing money from your savings account through an ATM is considered a convenient way to transfer funds. Due to ATM withdrawal limits, you are usually limited to six such transfers per month. If you exceed this limit, your bank may charge a fee.
Unfortunately, there’s no way around transfer and withdrawal limits, so try to plan ahead for your monthly needs. Think ahead about what major financial events you have coming up in the next few weeks and try to focus your withdrawals.
Let’s say that one weekend you need to take money out of your savings account to buy a friend a wedding gift, and the following weekend you’re taking a trip out of town. Even though these two events are separate, you’ll want to take all the money out of your account right away.
Minimum Balances
In addition to federal government restrictions, other regulations regarding your savings account may come directly from your financial institution. Some may require you to maintain a minimum daily balance. This is especially true for accounts with higher interest rates or other relevant features.
Before signing up for a particular account, be sure to understand these and any other requirements, as well as the penalties for violating them. You don’t want to add fees for routinely falling below the minimum daily balance. A little bit of knowledge goes a long way in keeping your finances in check.
Types of Savings Accounts
As mentioned above, banks and credit unions offer three common types of savings accounts:Basic Savings Accounts, Money Market Accounts, and Time Certificates of Deposit.
Each has different pros and cons, so it’s best to learn about all of them to find the one that works best for you. Some people even like to spread their savings across several types of accounts.
It all depends on what you plan to do with your money and when you want to access it. Knowing all the details of each plan type can prevent you from getting into financial trouble down the road.
Basic Savings Account
A basic account is just that – an easily accessible account that lets you keep your money separate from your checking account. While you do earn interest from it, don’t expect it to be a lot.
In fact, on the low end, you’ll only earn 0.01%, while a high-yield savings account will still only earn 4% APY (Annual Percentage Yield). Nonetheless, the low interest rates are compensated by easy access to funds. If there is a physical branch nearby, you can use your debit card to withdraw money directly from the bank’s ATM.
With online banking, electronic transfers can be done as early as the same day. In some cases, it may take longer, such as if you complete the transaction late at night or on a weekend or holiday.
Another benefit is that they have low or no minimum balance requirements. If you’re just starting out, this is a convenient and cost-effective way to save money. For beginners and seasoned savers alike, having a basic high-yield savings account makes saving money both easy and quick.
Money Market Accounts
For a slightly more complex savings product, consider a money market account. You’ll need a higher deposit to get started than with a regular account, but you’ll benefit from better interest rates.
You’ll likely find money market accounts with APRs between 0.75% and 1.2%. Just like a regular savings account, you can access your money whenever you want – as long as you maintain the minimum balance requirement.
These accounts are also subject to federal withdrawal and transfer limits, so plan accordingly. To open an account, you’ll need to commit to an initial deposit of $1,500 or more.
Many banks will tier deposit levels so that the more cash you deposit into the account, the higher the interest rate you’ll receive. If you have a large deposit that you don’t plan on spending in the near future, then it may be an option for you.
Certificate of Deposit
To get the highest interest rate on your savings account, you may want to consider certificates of deposit, also called large certificates of deposit. Depending on the bank or credit union, interest rates start at 0.5% and go up to 1.0% or more. There’s usually no charge to open an account, and the risk is low because most banks that issue large certificates of deposit are FDIC-insured. So what’s the catch?
When you open a term certificate of deposit, you must choose a commitment period during which you can’t make withdrawals. The longer the term you choose, the higher the interest rate. Most term deposits range from 6 months to 5 years, so you must have a financial plan.
If you decide to take your money out early, you will be charged a fee for the interest deducted over a certain period of time. For example, if you take out your money early, your bank may withhold interest for the last three months.
How should you choose a savings account?
There are a few different considerations to think about before getting into a savings account. Start by thinking about your savings as a whole and how you might need to use your money.
If you’re just starting to save, keep your emergency fund in an accessible account so that withdrawals don’t take time or incur fees. As you save more, consider diversifying your account types and investing in higher-yielding funds, even if it requires a larger deposit.
Maintaining a large minimum balance may sound difficult. However, if you’re saving for a long-term goal, it may prevent you from spending your money on other things. Unless there’s a term limit, you can always close the account when you make a withdrawal so you don’t have to pay maintenance fees.
Most banks have savings accounts insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 dollars. Credit unions are the same way, except they are insured by the National Credit Union Administration (NCUA).
Moving Money Around
Don’t worry about getting things right the first time. That’s the beauty of most savings accounts – you can open and close them as needed.
You might seek a sign-up bonus and just transfer funds once or twice a year. Or you could purchase cd’s of varying lengths so you can close them for a set period of time.
While choosing your savings account requires planning, it also requires periodic adjustments. Make a decision and after a few months, check in with yourself to see how it’s working out.
How do you open a savings account?
Depending on the bank or credit union, you can open an account online or in person. Most banks offer online savings accounts. However, smaller banks and credit unions may require you to go in person.
Either way, the process is simple. All you need is an ID, Social Security number, personal information and a required minimum deposit. If you already have an online savings account with your bank, the process is even easier because they already have your basic information.
Online and Mobile Banking
Once you’ve opened a bank account, you can sign up for online banking and download an app if your bank offers one. This makes it easy to access your online savings account, plus scan and deposit checks from anywhere. You can also link your savings account to your checking account so you can transfer money easily.
Opening one or more savings accounts is a very useful tool for managing your finances. It can help you stay on top of your savings goals while also providing easy access to your money when you need it. Take a few minutes to consider your options and then start making the best choices today – there’s no reason to wait.
FAQs
What is a High Yield Savings Account?
A high-yield savings account is a type of savings account that offers a higher interest rate than traditional savings accounts. These accounts are designed to help you earn more money from your savings balance, and they are usually offered by online banks or credit unions.
High-yield savings accounts are a suitable option for those who have larger balances and are looking for a higher return on their savings. However, it’s important to remember that high-yield savings accounts may not always offer the highest interest rates. There may be other types of investment accounts, such as money market accounts or certificates of deposit (cd’s), that offer higher returns.
Can I withdraw money from my savings account at any time?
Yes, you can usually withdraw money from your savings account at any time. However, there may be a limit on the number of withdrawals you can make each month. Some savings accounts may also charge fees for certain types of transactions, such as using out-of-network ATMs. Be sure to check your account’s terms and conditions for any potential fees or restrictions.
Is a savings account the same as a checking account?
No. Savings accounts and checking accounts are two different types of bank accounts. Checking accounts are typically used for everyday expenses and transactions, such as paying bills, making purchases, and withdrawing cash.
On the other hand, savings accounts are designed to save money and earn interest. Checking accounts are usually more flexible and convenient for everyday transactions, but savings accounts usually offer higher interest rates.
Can I have both a savings account and a checking account?
Yes, you can have both a savings account and a checking account at the same bank or credit union. Having both types of accounts is a smart financial strategy. You can use a checking account to pay for everyday expenses and a savings account to pay for long-term goals, such as a down payment on a home.
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