Instead of keeping all of your money in an easily accessed checking account where you’re more apt to spend it, it’s smart to spread some of the excess into a savings account.
There are a few restrictions, but you have the chance to earn interest on the money within the account. That’s why it’s better to place your cash reserves in this type of account rather than simply letting it sit in your checking account.
When deciding on your savings account, you’ll have three different types to choose from. We’ll go into those in greater detail, as well as other factors you should consider during the selection process.
You’ll also learn more about how interest accrues and how to open either an online savings account or one at a physical bank. When you’re finished reading, you’ll have a solid understanding of how savings accounts work and the best way to use one for your own finances.
How does interest accrue in a savings account?
Interest on a savings account doesn’t accrue once per year; instead, it’s compounded over multiple intervals. The exact frequency depends on the specific account you choose. The best option, assuming all other features are equal, is a daily compounding rate.
Other options include monthly or quarterly compounding. So, how exactly does compound interest work? You earn interest on your account for each interval.
Annual vs. Daily Compounding Rate
Let’s say you open a savings account with $5,000 that earns a 1% interest rate. If your interest-only compounded annually (once per year), you’d earn just $5 at the end of the year.
But when the interest on the same account compounds daily, your money starts to earn a bit more. Your 1% interest is divided up over every day of the year, technically amounting to 1/365th of a percentage point daily.
Over the course of the year in this scenario, it becomes the difference between making $50 in interest with an annual compounding rate and $50.25 with a daily compounding rate. The difference may seem laughable, but over time, that change can really add up.
Adding More Money & Rising Interest Rates
This is especially true when considering two variables. The first is that you’ll continue adding more money to your savings account. By doing so, you’ll continue the snowball effect that small additional amounts of interest will accrue into much larger amounts over time.
The other variable is that interest rates will rise over time. While earning even 1% interest right now is a rarity, savings account rates have historically been much higher.
As the years progress and the economy hopefully continues to strengthen, so will the benefits of compounding interest. As with most things, patience is a vital component of your financial longevity.
Are there any restrictions on a savings account?
Yes, there are restrictions on savings accounts. Some apply across the board to all accounts, while others depend on the specific account you choose.
Broadly, the federal government imposes a limit on how many transfers or withdrawals you can make each month, specifically ones that are deemed “convenient.” This includes any type of transfer, whether it’s online or by check or debit card.
ATM Withdrawal Limits
An ATM withdrawal from a savings account, however, does not count as a convenient transfer. You may only perform six such transfers each month. Otherwise, you’ll be hit with a fee from your bank.
Unfortunately, there’s no way around the transfer and withdrawal restriction, so try to plan your monthly needs in advance. Think ahead about what major financial events you have coming up in the next few weeks, and try to batch your withdrawals together.
Say you’ll need money from your savings account to buy a wedding gift for a friend one weekend, then take an out-of-town trip the next. Go ahead and take out all the money from your account at once, even though the two events are spread out.
On top of federal restrictions, other rules regarding your savings account may come directly from your financial institution. Some may require that you maintain a minimum daily balance. This is especially true with accounts that have higher interest rates or other features associated with it.
Before signing up for a particular account, be sure to understand these and any other requirements, along with the penalty for breaking them. You don’t want to rack up fees because you constantly dip below the minimum daily balance. A bit of knowledge can go a long way in keeping your finances in order.
What kind of savings account can you choose from?
As we mentioned earlier, banks and credit unions offer three types of savings accounts: basic savings accounts, money market accounts, and CDs.
Each one has different pros and cons associated with it, so it’s good to learn about all of them to find the best fit for you. Some people even prefer to spread out their savings over several types of accounts.
It all depends on what you intend to do with your money and when you want to access it. Understanding all the details of each plan type can prevent you from getting stuck in a financial pinch later down the road.
Basic Savings Account
A basic account is just that — an easily accessible account that allows you to store your money separate from your checking account. While you do earn interest with it, don’t expect it to be much.
In fact, on the low end, you’ll receive just 0.01% while a high-yield account still only earns about 1% APY (annual percentage yield). Still, the dismal interest rates are compensated by easy to access funds. You can withdraw them directly from your bank’s ATM with a debit card if you have a physical branch near you.
With online banks, an electronic transfer can go through as quickly as the same day. It may take a bit longer in certain situations, like if you complete the transaction late at night or on a weekend or holiday.
Another advantage is that they come with low or no balance minimums. If you’re just starting to save, this is a convenient and cost-effective way to store your money. Saving money is easy and fast for beginners and seasoned savers alike with a basic high-yield savings account.
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Money Market Account
For a slightly more sophisticated savings product, consider a money market account. You’ll need a higher deposit to get started than you would with a basic account, but you’ll benefit from a better interest rate.
You’ll likely be able to find a money market account with an APY ranging between 0.75% and 1.2%. Just like a regular savings account, you can access your money anytime you’d like — as long as you maintain the minimum balance requirements.
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These accounts are also subject to the federal withdrawal and transfer limits, so plan accordingly. To get an account started, expect to commit to an initial deposit of $1,500 or more.
Many banks tier their deposit levels so that the more cash you put into your account, the better interest rate you’ll receive. If you have larger levels of savings that you don’t anticipate digging into too much in the near future, it could be a good option for you.
Certificate of Deposit
To get the highest rate on a savings account, you can consider a certificate of deposit, also called a CD. Depending on the bank or credit union, rates start at 0.5% and can go just above 1.0%. There’s typically no fee to open an account and the risk is low since most banks issuing CDs are FDIC-insured. So, what’s the catch?
When you open a CD, you must select a commitment period in which you won’t make any withdrawals. The longer term you select, the better rate you’ll receive. Most CD terms range anywhere between six months and five years, so you definitely need to have a financial plan.
If you do decide to withdraw the money early, you’ll be hit with a fee charged as a deduction of interest from a certain amount of time. For example, if you take out money early, your bank might withhold the interest earned from the last three months.
How should you choose a savings account?
There are a few different considerations to think about before jumping into a savings account. Start by thinking about your savings as a whole and how you might need to access your money.
If you’re just starting to save, keep those emergency funds in an accessible account that doesn’t take time or accrue fees whenever you make a withdrawal. As you save more, consider diversifying your account types and putting funds in a higher yield fund — even if it means larger deposits or a term limit commitment.
Maintaining a large minimum balance might sound difficult, but if you’re setting aside money for a long-term goal, it may keep you from the temptation to spend the funds on something else. And unless there’s a term limit, you can always close the account when it’s time to withdraw so you don’t have to pay a maintenance fee.
Most savings accounts at banks are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000. The same holds true for credit unions, except they are insured by the National Credit Union Administration (NCUA).
Moving Money Around
Don’t worry about getting it all right the first time. That’s the great thing about most savings accounts—you can open and close them as needed to suit your needs.
You might look for sign-up bonuses and simply move your money around once or twice a year. Or you could purchase CDs in varying lengths so that you get on a schedule of having the term end consistently.
While choosing your savings account does take planning, it also takes regular adjusting. Make a decision, and in a few months, check-in with yourself and see how it’s working.
How do you open a savings account?
Depending on the bank or credit union, you can either open an account online or in-person. Most places allow you to do this over the Internet, but smaller banks and credit unions may require you to go in person.
Either way, the process is simple. You just need your ID, social security number, personal information, and the required minimum deposit. The process is even simpler if you already have an online savings account with the bank since they already have your basic information.
Online & Mobile Banking
Once you’ve opened your bank account, you can sign up for online banking and download an app if the bank offers one. This can make it easy to access your account on the go, plus scan and deposit checks from anywhere. You can also link your savings account to your checking account so that you can transfer money easily.
Opening one or more savings accounts can be an extremely useful tool in managing your finances. It can help you stay on top of your savings goals while also having easy access to your money when you need it. Take a few minutes to consider your options, then get started with the best choice today — there’s no reason to wait.