Wed. Mar 3rd, 2021

Savings accounts have been around in the U.S. since 1816, when the first American savings banks opened in Boston and Philadelphia.

Offered by banks and credit unions, savings accounts provide a safe place to keep money and earn a small amount of interest. You add to or subtract from them by making deposits and withdrawals quickly and conveniently. Savings accounts in some ways stand apart from these other kinds of banking vehicles:

  • Checking. Account holders primarily use these to pay bills via checks, automatic payments, debit cards or online platforms.
  • Money market accounts. These act like savings accounts but typically pay higher interest.
  • CDs. Also known as certificates of deposit, CDs usually offer better interest rates than savings, checking or money market accounts. The interest depends on the maturity date: The later that is, the more you earn. Here money is the least liquid; you can’t touch it until the CD matures or else you will pay a penalty.

Even with all the financial options savers can choose from, they still generally choose a savings account, according to a 2019 U.S. News survey. Nearly half of respondents said they put away their money in a savings account, more than twice as much as any other option. So, what are the advantages or disadvantages of opening a savings account and keeping your money there? This overview will answer those questions and guide you toward making smart decisions with your hard-earned money.

If you know how a piggy bank works, then you get the gist of a savings account. Your money moves in two directions: in (deposit) and out (withdrawal). But if it’s that simple, why not just use a ceramic pig or a coffee tin with a slot cut out in the lid?

To begin with, saving money that way isn’t secure: It can be lost or stolen all too easily, and there’s next to nothing stopping you from using the cash impulsively. In a bank or credit union, your money is safe, protected under law by the Federal Deposit Insurance Corp. or the National Credit Union Administration.

Here are some frequently asked questions regarding savings accounts:

Is there a limit on how much I can deposit into my savings account?

No, according to the Consumer Financial Protection Bureau. And if you have $250,000 or less combined in all of your deposit accounts at the same insured bank or credit union, you do not need to worry about your insurance coverage – your deposits are fully insured by the federal government.

Is there a savings account withdrawal limit?

Yes, on the number of withdrawals. Banks are highly regulated by the Federal Reserve, and Regulation D – “Reg D” for short – limits you to six transactions per month on certain transfers and withdrawals from your savings account. This applies to common transactions such as automatic or preauthorized transfers, bill payments, debit card payments or any other recurring transfers. The good news is that Reg D does not apply to withdrawals or transfers made at ATMs, or withdrawals made in person at a bank branch. For most people, this restriction apparently isn’t a problem. In a 2019 survey by U.S. News, less than 20% of respondents said they withdrew funds from their savings account once or more each month. About a quarter of respondents said they almost never took money out.

What are some common fees, and how can I avoid them?

Let’s go back to the limits imposed by Reg D. If you go over the six transaction limit, your bank could charge you as much as $15 per instance. Regardless, some banks will charge a monthly maintenance fee (often $5 or less) if your account doesn’t meet a minimum balance. The best way to avoid these fees is to learn about them from the bank beforehand and comparison shop for the lowest and least fees.

What are the typical interest rates, and how does interest work?

Interest rates for savings accounts and related savings vehicles vary widely, from as low as 0.01% annual percentage yield to as high as 0.81% APY at Varo Bank. The national average rate for savings accounts is 0.05%, according to the FDIC. Online banks typically offer the highest interest rates.

APY represents the effective annual rate of return taking into account the effect of compounding interest. With compounding, interest adds to the account balance, which in turn earns more interest, much as a snowball gets larger as it rolls down a hill. Keep in mind that the IRS will tax your interest through a 1099 form, just as though it were income earned from a part-time job.

What does my bank do with my money?

Banks use your money to finance loans to consumers. For this reason, competition between banks to land new savings accounts has become fierce. Still, that doesn’t mean you’ll earn a great return on your money in a savings account.

Savings accounts act as a place where you can store money safely and retrieve it easily, a concept known in financial circles as high liquidity. These characteristics make a savings account ideal for short-term financial needs and goals such as:

  • Emergency fund. The rule of thumb is to put away at least three to six months’ worth of living expenses. While that amount may seem challenging, contributing small amounts each week can help you reach that goal, and a savings account is a good place to stockpile it. In fact, according to a U.S. News survey conducted in 2019, about 40% of respondents use their savings account as an emergency fund, about four times as much as for any other purpose.
  • House down payment. In December 2020, the median home down payment was $20,775, according to ATTOM Data Solutions.
  • Large purchases such as a car or vacation. These remain popular uses for savings accounts, just as they were in the 1960s and ’70s, when banks routinely offered “vacation club” voucher booklets to help savers keep on target with their goals.
  • Seed money for college. If you’re in the initial stages of collecting college money from various sources – family or summer jobs, for example – a savings account can act as a central location to keep the funds organized and in one place.

But as your financial goals shift to a longer range, savings accounts become less desirable because they are meant as a place to hold money rather than grow it. For example, you may want to put college savings into a 529 plan, a tax-advantaged investment vehicle.

This brings up an important point: While some people believe that putting their money in a savings account is a form of investing, “The worst investment you can have is cash,” billionaire investor Warren Buffet has said. And a savings account, more or less, is a place where you store cash.

Some investment experts have compared savings accounts to putting money in a shoebox. It’s not quite that bad – after all, savings accounts are insured by the federal government. But the interest a savings account earns, as a rule, does not keep up with inflation, which means that over long periods, keeping money in a savings account amounts to losing money.

There are three common ways savers open accounts:

In person. The most traditional way to open a savings account is to visit a bank or credit union branch in person. In fact, many people still prefer this option, as it allows them to ask questions of a bank or credit union employee face to face.

To start your account, you will need to bring enough money – via cash, check or debit card – to meet the bank’s minimum balance requirement. Check in advance to avoid wasted time.

Make sure to bring along an official photo identification such as a driver’s license or passport and have your Social Security number handy. If you’re opening a joint account, both parties should be present with proper ID. If you’re younger than 18, you will need an adult present to sign on as the account custodian.

Online. Both conventional banks and online-only banks will allow you to open a savings account via the internet. Just as in person, you’ll need to provide information from an official government ID and your Social Security number. If you need to make an opening deposit, you’ll use a debit card or provide the routing and account numbers from another account.

By phone. This works much the same way as opening an account online, except that a customer service representative will walk you through the process. One advantage to applying by phone as opposed to online is that you can direct your questions to an actual person and get real-time answers as you go.

Even though you are bringing your money to the bank, you can still be turned down for a savings account. The reasons include unpaid fees, bad credit, overdrafts on other accounts, a fraud conviction and bounced checks.

Prospective account holders also get turned down for insufficient identification, which is easy to avoid if your bring along your official photo ID.

The choice between online banks and credit unions for savings accounts versus a traditional bank often boils down to two factors: fees and interest rates.

At some major banks, the interest rate for a savings account will be next to zero. As of December 2020, a Chase savings account offered 0.01% APY and charged a $5 monthly fee if you carry less than the minimum balance. Based on these terms, a $100 account left alone would be worth $40 a year later. That’s not really saving, is it?

For online-only savings accounts, it’s a different story. The Marcus by Goldman Sachs account offered a 0.5% APY and no monthly fee. So that same $100 account would be worth $100.50 a year later. Credit unions, meanwhile, commonly offer better interest rates than banks, but you’ll have to shop around, as rates will always vary depending on factors such as the minimum account balance and special promotions.

Traditional banks – especially on the community and regional level – as well as credit unions have one distinct advantage: It’s easier to build one-on-one relationships. Today’s saver could be tomorrow’s entrepreneur. Knowing your banker (and vice versa) sets the stage for trust that builds over time, just like the interest in your bank account. When you’re ready for that next financial leap, you won’t be making a cold call on your own financial institution – and you’ll already have a track record.

Opening a savings account for your child is an excellent way to teach them personal finance 101. A child who is old enough to actively participate in the account can make regular deposits and experience the excitement of watching their balance grow over time. Another advantage of a child’s savings account is that while a boy or girl can easily raid a piggy bank, making a withdrawal at a brick-and-mortar bank (or even an online bank) requires more consideration and planning. It gives parents an ideal opportunity to talk about spending with their kids and help them make good decisions.

A parent will take joint ownership of an account opened in a child’s name, an arrangement known as a custodial account. This means that as the custodial parent, you have full access to the account. However, anyone not named as a custodian on the account – a spouse or grandparent, for example – cannot access it.

One advantage of having an account in a child’s name is that they will feel a sense of pride at having their own place to organize their savings. Walking up to a bank teller window is a very adult thing to do. As they become technologically savvy, you can teach them how to use a smartphone to deposit a check through your bank’s app, a process known as remote deposit capture.

Whenever possible, select an account option that has no minimum balance requirements and charges no fees. Age 18 marks a milestone for the account, as a parent can sign over custodial rights and the teenager takes full control of the funds and has sole access to them.

Several factors differentiate savings accounts, money market accounts and certificates of deposit.

Liquidity. Turning the money from a savings account into cash can take seconds, which makes savings accounts nearly as liquid a savings vehicle as a piggy bank. Money market accounts may come with checks or a debit card, making them just as liquid. The least liquid of all are CDs, which lock up your funds for a set amount of time. You can’t touch the money until the CD matures without incurring a penalty.

Interest rates. In general, a bank savings account will pay the least amount of interest, with money market accounts paying more and CDs the most. If you need a safe place to park your money and won’t need access to it, a CD could be your best bet.

Penalties. In many cases, a savings or money market account won’t have any penalties attached to it, though some savings accounts carry monthly service charges that can eat into your funds. Whenever possible, choose a savings account that doesn’t penalize you for falling below a minimum balance or charge fees for you to keep your money there. With CDs, it’s a different story. For CDs of up to a year, you may be looking at sacrificing three months of interest for early withdrawal. But depending on the financial institution, you can ask for waivers that bypass early withdrawal penalties.

To make the best decision, start by weighing the need for liquidity versus interest return. Remember that making the best savings choice isn’t an all-or-nothing proposition. You can deposit some money in a money market account and some in a savings account, which will also help you to keep funds earmarked for different purposes.

While the idea of multiple savings accounts may sound redundant, it makes a lot of sense when you consider how individual accounts can help keep financial goals from overshadowing each other. For example, you may want to open one savings account that serves only as an emergency fund, another to save for holiday purchases or a third to pay for a vacation. (Have you tacked up that Hawaii photo yet?)

Note that the money in these accounts may not keep up with inflation, so it’s best to use them for shorter-term goals or in instances where you’ll want immediate access to the funds.

Still – and here’s the good part – the money isn’t quite as easy to access as cash in your wallet. There may even be some healthy guilt involved in touching an account for potentially frivolous reasons when, after all, you’ve dedicated it for a special purpose beyond your immediate gratification. To remind you of this, it may even make sense to create these purpose-driven accounts in a bank or credit union other than your main financial institution. To avoid temptation, don’t carry any debit cards for these accounts, which might tempt you to tap them instead of your everyday-use account.

With kids, opening separate accounts can head off inevitable squabbles about whom the money in a single account belongs to. And as siblings have a penchant for comparing everything, multiple accounts help you to keep close tabs on making things equal.

While creating multiple savings accounts can provide organization and motivation to fund your pet projects, be careful not to spread yourself too thin. One separate account may be enough to use for one goal and then reuse for another once its mission is accomplished. Begin with the end in mind, and ask yourself how many accounts it makes sense for you to manage without becoming overwhelmed or your repositories underfunded.

410(k). A retirement account created in conjunction with a private employer.

529 plan. A special savings account for education-related expenses such as tuition, meal plans and computers. It provides for investment growth and tax advantages that are similar to retirement accounts.

ACH. Automated clearing house, an electronic network for fund transfers such as bill payments and payroll direct deposit.

APY. Annual percentage yield, the effective annual rate of return taking into account the effect of compounding interest.

CD. A certificate of deposit. It earns a higher rate of interest than a savings account, based on a maturity date where the depositor cannot touch the funds without incurring a penalty.

Check clearing. The process of the funds in a check becoming available for the payee to use. When the funds are fully available, the check is said to have “cleared.”

Compounding interest. The further effect of interest on an account that has already collected interest. If a $100 account collects 10% interest per year, you will have $110 the first year and $121 the second year as a result of compounding interest.

Credit union. A nonprofit money cooperative that functions much like a bank. Members can borrow from pooled deposits at generally low interest rates. Savings accounts at credit unions typically accrue more interest than at banks.

Direct deposit. When the funds in a check are routed directly to your account without your having to endorse a paper check. Direct deposit is commonly used with employee paychecks.

Funds availability. The amount of money in an account that the account holder can use. When the account balance is higher than the funds available, it often reflects that the funds in a check deposited to the account have not yet cleared.

IRA. Individual retirement account. In a traditional IRA, the funds in these accounts are invested and the resulting growth is not taxed.

Money market account. A savings account-type financial instrument where the money is invested solely in cash and cash-equivalent securities. In general, MMAs earn higher interest than savings accounts and may require higher minimum balances.

Remote deposit capture. A method of depositing endorsed checks into an account by submitting pictures of them through a bank’s mobile app.

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