A savings account is an interest-bearing deposit account held at a bank or other financial institution. Although these accounts typically offer modest interest rates, their safety and reliability make them an excellent option for managing funds intended for short-term needs.
Savings accounts might have some withdrawal limitations but generally offer exceptional flexibility, ideal for building an emergency fund, saving for short-term goals like purchasing a car or going on vacation, or simply earning interest on surplus cash from your checking account.
Key Takeaways
- Savings accounts pay interest while keeping your funds easily accessible, making them a great option for emergency or short-term cash.
- They provide ease and liquidity, albeit at a lower interest rate compared to more restrictive savings instruments or investments.
- Withdrawals from a savings account are generally unlimited in amount, though frequency may be restricted.
- The interest earned on a savings account is taxable income.
How Savings Accounts Work
Savings and other deposit accounts are crucial for financial institutions, supplying funds needed for loans. You can find savings accounts at almost every bank or credit union, whether they operate traditionally with physical locations or exclusively online. Some investment and brokerage firms also offer savings accounts.
Savings account interest rates vary widely. With few exceptions, such as those involved in promotions offering fixed rates, banks and credit unions can change their rates at any time. Typically, the more attractive the rate, the more likely it is to fluctuate.
Adapting to Interest Rate Changes
Changes in the federal funds rate often prompt institutions to adjust their deposit rates. Some banks offer high-yield savings accounts, providing notably higher interest rates for larger minimum deposits—a worthwhile consideration for strategic savers.
Features to Consider
Savings accounts typically require a minimum balance to avoid monthly fees or earn the best rates. Familiarize yourself with your account’s rules to avoid fees that could reduce your earnings.
Transfers to and from your savings account can be made online, at branches or ATMs, via electronic transfers, direct deposits, and over the phone.
Pros and Cons of Savings Accounts
Pros:
- Simple setup and money transfers
- Convenient linkage with your primary checking account
- Complete balance can be withdrawn anytime
- Up to $250,000 is federally insured against bank failure
Cons:
- Pays less interest than certificates of deposit, Treasury bills, or other investments
- Easy access could lead to tempting withdrawals
- May require minimum balances
In-Depth Look at Pros
Convenient and Efficient: Holding a savings account at the same institution as your primary checking account offers significant convenience. Transfers between these accounts are typically instantaneous, facilitating real-time deposits and withdrawals.
Linked Benefits: Linking a savings account to your primary checking account makes it easy to transfer excess cash quickly.
Liquid Access: Savings accounts offer highly liquid access to funds, unlike certificates of deposit, which levy substantial penalties for premature withdrawals.
Federal Protection: Funds are protected up to $250,000 by Federal Deposit Insurance Corp. (FDIC) insurance, ensuring your deposits are safe in the event of a bank failure.
Detailed Cons Lower Interest Rates: The trade-off for the easy access and safety of savings accounts is a lower interest rate than other savings instruments. Higher returns can be achieved with certificates of deposit, Treasury bills, or long-term investments like stocks and bonds.
Tempting Withdrawals: The readily accessible nature of savings accounts may tempt you to withdraw saved funds frequently.
Minimum Balance Requirements: Some savings accounts require minimum balances to avoid fees or access the best interest rates.
Strategies to Maximize Savings Account Earnings
Despite low standard interest rates, it’s possible to find better returns by comparing different banks and credit unions—especially focusing on online banks, which often offer higher rates due to reduced overhead costs.
Start by comparing the savings rates offered by your current bank to establish a reference point. Promotional rates may only last for a short period, or might be limited to specific balances. Be cautious of accounts with fees that could offset your earned interest.
Opening a Savings Account
To open a savings account, visit a bank or credit union branch or conduct the process online. You’ll need your name, address, telephone number, and photo identification. Additionally, because the account earns taxable interest, you’ll need to provide your Social Security number.
Some institutions may require an initial minimum deposit to open the account. Deposits can be made via transfers, checks, or in person at a branch.
Managing Savings Balances
The amount you keep in your savings will depend on your financial goals or intended use of the account. For sweeping excess funds from a checking account, balances will naturally fluctuate. For building towards a savings goal, balances will likely increase over time.
For an emergency fund, financial advisors typically recommend keeping enough in your savings to cover three to six months of expenses. However, some suggest keeping only a portion in a simple savings account and placing the rest in higher-yielding instruments.
Both FDIC and NCUA insurance protect up to $250,000 in deposits within each institution. If your savings exceed this, consider splitting across multiple accounts or institutions.
Opening and Closing Procedures
To open a savings account, bring your government ID and any initial deposits to a bank branch or apply with an online bank. Closing an account is straightforward—visit in person, submit a written cancellation, or close it over the phone, usually requiring identifying information.
Conclusion
Savings accounts offer a straightforward way to earn interest while keeping funds easily accessible. Although they provide lower interest rates compared to other investments and don’t keep pace with inflation, they remain a versatile and secure option for managing short-term savings and emergency funds.
Related Terms: emergency fund, interest rate, high-yield savings account, certificate of deposit, online banking.
References
- Federal Reserve. “Regulation D: Reserve Requirements”, Page 3.
- Board of Governors of the Federal Reserve System. “Federal Reserve Board Announces Interim Final Rule to Delete the Six-Per-Month Limit on Convenient Transfers from the Savings Deposit Definition in Regulation D”.
- Internal Revenue Service. “About Form 1099-INT, Interest Income”.
- Federal Deposit Insurance Corp. “Deposit Insurance”.
- National Credit Union Administration. “How Your Accounts Are Federally Insured”.
