What is a Savings Account?
A savings account is an interest-earning deposit account held at a bank or credit union. Savings accounts earn interest income, which helps your account grow. While these accounts usually earn a modest interest rate, they can be ideal for depositing and saving money. Many savings accounts also offer the flexibility to make withdrawals and transfers, allowing you to quickly move funds from a savings account to a checking account. However, many accounts will have withdrawal limits to encourage you to keep your funds in the savings account.
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How Does a Savings Account Work
Most banks and credit unions offer savings accounts to customers because these deposits are important sources of funds for these institutions. Savings accounts vary slightly from bank to bank but generally provide similar features.
Savings accounts are interest-generating accounts. Depending on the interest rate environment, banks often compete for customers based on how much interest they will provide on your savings. Interest rates are meant to reward you for deferring your consumption and can generate an income stream.
It is critical to keep in mind that your funds are not meant to be withdrawn regularly from a savings account. Many banks place caps on the number of monthly withdrawals you can make before facing penalties. Everyday spending should be with a checking account, instead of a savings account.
Savings accounts also have minimum balances ranging from zero to several thousand dollars. These minimums give banks some assurance over their fund amount and encourage you to keep savings in the savings account and not treat your savings account as a checking account.
Best Savings Accounts
Not all savings accounts are the same. Some have high savings yields, while others offer products with more established banking brands, easy access to ATMs, lower minimum opening balances, and minimal fee structures. Check out Smart Money's best savings accounts to select the best savings account for you.
Pros of Savings Accounts
Easy To Set Up: Setting up a savings account takes a couple of minutes. You can set up an online savings account quickly with no impact on your financial health or credit score. Make sure you conduct your research and contemplate whether you want to work with this bank in the future. Closing a bank account is relatively seamless, just a hassle.
Quick Access to Cash: Savings accounts are highly liquid. Unlike other interest-generating savings accounts, like certificates of deposits, savings accounts allow you fast access to your cash. There is no early penalty for withdrawing funds. You can transfer funds online or in person.
Add or Withdraw Funds: Another attractive feature of savings accounts is that you can add funds freely and earn more interest on your growing total fund balance. Although interest rates fluctuate with savings accounts, the tradeoff is that you can add more savings whenever you want. Additionally, once you have met your savings goals (car down payment or wedding fund) you can transfer funds out of your account to make a purchase.
Federally Insured: Savings accounts with banks are insured by the FDIC, and savings accounts with credit unions are insured by the NCUA (more on this below).
Cons of Savings Accounts
Less Interest: In general, savings accounts have lower interest rates than other saving instruments because of their easy access to funds. Savings vehicles that require fixed terms, such as certificates of deposits, bonds, or Treasury bills, offer higher interest rates. To get the best of both worlds, you can store your cash in a high-interest-rate savings account.
Quick Access to Cash: We list this as a pro and a con because access to your cash can make it tempting to spend money. That is why placing your cash in investments with a fixed term or investing in the stock market increases the barrier to fund movement. This barrier helps blunt temporary urges to spend frivolously.
Fees and Minimum Balances: Savings accounts offering the highest interest rates also come tethered to minimum balances and early withdrawal fees. These cons can be mitigated with financial planning and budgeting. High-yield savings accounts can fit perfectly into your financial ecosystem with thoughtful planning.
Why You Need a Savings Account
For everyday spending needs, you should use your checking account. However, savings accounts are great places to start saving funds to distance yourself from the paycheck-to-paycheck lifestyle. By contributing regularly to an interest-earning savings account, you can grow your money without much work on your end. You can use your savings account to meet short-term savings goals like saving for a down payment for a car or emergency fund.
Smart Tip:
Depending on your budget system (read more about the pay yourself first budget or 50/30/20 budget), storing excess cash in a savings account is a smart money move.
Are My Savings Funds Insured?
Savings accounts are federally insured for up to $250,000. This means that if a bank or credit union fails, your savings are federally insured by the FDIC or NCUA, respectively. Insured deposits make a savings account attractive for storing your excess cash.
Other Types of Accounts Used by Savers
Growing your money is simply a matter of deciding where to stash your cash. Here are some liquid short-term accounts that can help add money to your pocket.
- High-Yield Savings Account: High-yield savings accounts stand out from regular savings accounts because they are among the best. Online banks and credit unions offer high-yield savings accounts because they offer the benefit of safety with juicier interest returns (see our Best High Yield Savings Accounts). High-yield savings accounts are perfect places to store your emergency fund, slush fund, or long-term savings goals.
- Certifications of Deposits: Certificates of Deposits (CDs) are also a type of savings account offered by many banks and credit unions. CDs offer investors the ability to save money at a fixed interest rate until a term date. There are over 7 types of CDs which you should consider. A critical difference between a CD and a savings account is that interest rates do not change for a CD.
- Money Market Account: Money Market Accounts (MMAs) are savings products offered by banks and credit unions with many of the critical benefits of a savings account mashed with the core features of a checking account. MMAs generally offer higher interest rates than regular savings accounts. These accounts can come with debit cards, check writing, and withdrawals from ATMs (making access to funds convenient), but unlike a regular checking account, they limit the number of transactions you can make per month. MMAs usually have required minimum deposits and balances.
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Smart Summary
Setting up a savings account is something virtually every personal finance professional recommends. Savings accounts serve as excellent warehouses for your cash while you are saving to meet short- and long-term financial goals. Earnings interest on those funds will help you achieve goals like savings for an emergency fund or slush fund. Alternative savings accounts, like certificates of deposits, can generate higher interest rates, but a good savings account is vital for your financial ecosystem.
