How Savings Accounts Work - Not Your Grandma’s Piggy Bank
Piggy banks may be cute, but they don’t have a very good interest rate. A savings account tends to be a safer place to store your money.
You’ve probably had a savings account for years (maybe even decades). But how much do you actually know about savings accounts? And are you getting the most out of your savings account? What makes it different from a checking account? We’ll answer these questions, and more, below.
Having a savings account could help you build wealth, protect your money, and maintain emergency funds, while also earning interest.
Interest rates on savings accounts depend on several factors, like the account type and compounding frequency.
When choosing a savings account, it's important to consider things like fees, minimum balance requirements, and transfer limits.
What is a Savings Account and How Does It Work?
Savings accounts are typically offered by banks, credit unions, and other financial institutions. When you have a savings account at a chartered banking institution, your deposits are protected by FDIC insurance. FDIC insurance protects your money in the event of a bank failure.
FDIC insurance is provided for up to $250,000 per depositor, bank, and ownership category. This means if you have more than $250,000 in one savings account at one bank, only the first $250,000 may be insured. However, if you have savings accounts at two different, FDIC-insured banks, each account is protected up to $250,000. The FDIC has a tool to help you determine how much coverage you have.
Unlike a checking account, which is primarily used for transactions, a savings account is a place for setting money aside and allowing the balance to grow over time, both through regular deposits and earning interest on your balance.
Savings Account Withdrawal Limits
It is important to remember that certain banks may limit the number of times you can access funds in savings accounts each month. This limit is usually six per month, due to Federal Reserve Board Regulation D.
The Federal Reserve Board, which supervises and regulates banks and financial institutions, adjusted Regulation D during the COVID-19 pandemic and removed the limit, meaning banks were no longer required to enforce it.¹ However, some institutions still have it in place or charge a fee if you withdraw more than the limit.
Additionally, not all transactions and transfers are subject to the limit. For example, ATM withdrawals don’t count toward the limit.
Be sure to check with your bank for any limits or fees they have on savings accounts.
Types of Savings Accounts
Remember that piggy bank you had as a kid? A savings account is kind of like that – a safer place to keep your money. Unlike a piggy bank, money in a savings account could grow over time with interest.
Savings accounts are typically broken down into three types, regular, money market, and Certificates of Deposit (CDs).
Type of Account
Interest-bearing deposit account that offers quick access to funds.
Like a savings account, but often have higher interest rates and some checking account abilities, like check-writing.
Certificate of Deposit (CD)
Requires you to deposit money for a fixed period of time in exchange for a higher interest rate. Deposits held in CDs often can’t be withdrawn without a penalty.
When it comes to savings accounts, where you bank matters. Savings accounts can be opened at traditional brick-and-mortar banks as well as digital-only banks. There are a few common differences between accounts held at these institutions, including:
Location of Savings Account
Brick-and-mortar bank (Ex. Banks and Credit Unions)
· Low minimum balance requirements
· Low interest rates (as low as 0.01% APY)
· Accessible through in-person branches
Digital or online savings accounts (Ex. Digital or online banks)
· Low minimum balance requirements
· Higher interest rates than traditional savings accounts
· No in-person branches
What is a High-Yield Savings Account?
You may have heard people talk about high-yield savings accounts. Contrary to what you may think, these accounts aren’t materially different from regular savings accounts. The primary difference is in their interest rate.
A high-yield savings account pays a higher interest rate than the national average. So basically, if your account is earning better than the average in interest, it can be considered in that high-yield category.
How Do You Earn Interest on a Savings Account?
Let’s be honest – interest is (probably) the main reason most people use savings accounts. Who doesn’t like “free” money? (Ok, it’s not exactly free because you have to report it on your taxes if it’s over a certain threshold, but you get the idea.)
Money in savings accounts typically earns interest at higher rates than money in checking accounts. Most banks express interest rates in Annual Percentage Yield (APY).
Quick Lesson in Compound Interest
APY can be compounded daily, monthly, or annually. Compounding refers to the process of reinvesting interest earned to increase total earnings over time, both on the original principal and past interest earned.
While interest may be compounded daily, it may not be posted to the account daily. Some institutions will give the account holder a running tally of the daily interest accrued on their savings balance, but only post the accrued interest to the account once a month.
For example, say you have an account with a 1% APY that compounds daily and you deposit $100. Each day you will earn .00274% (1% / 365) in interest. So after one day, your balance would be $100.00274. The next day, you earn .00274% on the new balance of $100.00274. After a year, your total balance would be $101.²
That said, you may not have access to the interest earned each day. Many banks deposit accrued interest to the account on a monthly basis.
The amount of interest you can earn on a savings account varies depending on the type of account, the bank, and current interest rates. In March 2023, the FDIC reported that the average national interest rate for savings accounts was 0.37%, while most online savings accounts were offering interest rates over 3.40%.³ According to eMarketer, a lot of consumers are missing out on interest they could be earning. They calculated this “lost” interest: if people in lower-rate accounts moved their savings into accounts with higher yields, they’d collectively earn $42 billion more in interest!⁴ That’s a big miss!
Oftentimes, digital banks offer higher than average interest rates on their savings accounts. This is due to their lower overhead costs because they don’t have in-person branches or their own ATM networks. Because of this, digital banks are able to offer their customers a higher interest rate on savings.
In March 2023, Bankrate released a study where they found that 60% of consumers are somewhat or very interested in using a digital bank in the next year.⁵ The study also found that the savings account interest rates for digital banks were between 3.00% – 4.40% APY, compared to just 0.01% – 0.02% APY for traditional banks.
How to Choose a Savings Account
Even if you’ve had a savings account for years, you may want to look for a new account if you feel like you aren’t getting the most bang for your buck.
When choosing a savings account, it is important to watch for the following:
Fees (minimum balance, excess transfer, etc.)
Minimum balance requirements
Tiered interest rates depending on deposit amount
Some banks may charge fees for maintaining the account or for certain transactions. Additionally, some accounts may require you to maintain a minimum balance to avoid fees or earn interest.
Some banks may also offer promotional interest rates that expire after a certain period of time. Be sure to read the terms and conditions to avoid unexpected fees or changes in interest rates.
A savings account is an important part of helping you to achieve financial stability and reach your financial goals. It provides a secure place to store your money, earn interest, and access funds in case of emergencies.
When comparing saving account options, be sure to look for things like favorable interest rates, low (or no) fees, and FDIC insurance.
Savings Accounts Q&A
How much should you keep in your savings account?
The amount you should keep in your savings account depends on your financial goals and personal circumstances. Financial experts recommend having three to six months' worth of living expenses saved in an emergency fund. Beyond that, it's up to you to decide how much you want to save for long-term goals such as a down payment on a house or a dream vacation.
Does opening a savings account affect your credit score?
No, opening a savings account does not affect your credit score. Savings accounts are not credit products and don’t involve borrowing money. Therefore, they don’t show up on your credit report, and opening one won’t affect your credit score.
How much does a savings account cost?
Savings accounts may have monthly maintenance fees or other fees, depending on the bank and account type. However, many banks offer fee-free savings accounts, so it's a good idea to shop around to find an account that meets your needs and fits your budget.
Can I have more than one savings account?
Yes! There’s no set limit on the number of savings accounts you can have. Some financial institutions may have internal limits, but you can open savings accounts at multiple banks. The number of savings accounts you need depends on your financial goals and needs.
What is the difference between a checking and savings account?
A checking account is designed for everyday transactions such as paying bills, making purchases, and withdrawing cash. It typically offers a lower interest rate and may have fewer restrictions on withdrawals.
A savings account, on the other hand, is designed for long-term savings and earning interest. It may have higher interest rates but may also have restrictions on withdrawals to encourage saving.