When you want to save money for future needs and aspirations, consider opening a savings account. A savings account, by definition, allows you to deposit money and earn interest on it. You can open these accounts at a bank or credit union. If you want to open a savings account, there are a few things you should know about how they work. In this post, we will explore the definition of a savings account, how it works, the 3 types of accounts, their advantages and disadvantages, and how to open a savings account.
Savings Account Definition
By definition, a savings account is a simple sort of financial product that allows you to deposit money and receive a small amount of interest. These accounts are insured by the federal government for up to $250,000 per account owner and give you a safe place for your money to grow and earn interest.
Savings accounts are available at banks and credit unions. You don’t need much money to open a savings account, and you’ll have fast access to your money, but you may be limited in how many times you may use it each month.
How Does a Savings Account Work
Savings and other deposit accounts are major sources of funds for financial institutions. As a result, you may find savings accounts at almost every bank or credit union, whether they are traditional brick-and-mortar establishments or just function online. Savings accounts are also available at several investing and brokerage organizations.
The account interest rates vary. Banks and credit unions can change their rates at any time unless they are running a promotion where the rate is locked in until a certain date. The more competitive the rate, the more likely it is to fluctuate.
Changes in the federal funds rate might cause financial institutions to change their deposit rates. Some financial organizations provide high-yield savings accounts, which are worth considering.
Some savings accounts need a minimum balance to avoid monthly fees or get the highest reported rate, while others don’t. Understand the restrictions of your specific account to prevent diluting your earnings with fees.
Some banks have placed a limit of six withdrawals per month after the Federal Reserve enforced the limit, which is to be lifted in April 2020. If you make more than six withdrawals, your bank may charge you a fee, terminate your account, or convert it to a checking account. The amount that can be withdrawn is simply limited by the amount in the account.
Savings account interest is taxable income, much like interest earned on a money market, certificate of deposit, or checking account. When you earn more than $10 in interest income, the financial institution where you keep your account will issue you a 1099-INT form. The amount of tax you will pay is determined by your marginal tax rate.
What is the Purpose of a Savings Account?
Because of its safety, liquidity, and interest-earning potential, a savings account is a smart place to put money for a later date apart from your daily spending cash. These accounts are perfect for keeping your emergency fund or short-term savings goals, such as a vacation or home repair.
Aside from making it easy to get to your money when you need it, savings accounts often have better interest rates than checking accounts. Some savings accounts may even offer a greater APY than money market accounts. The average APY on savings accounts is 0.19 percent, but high-yield savings accounts pay more than 4 percent.
What are the 3 Types of Savings Accounts
While there are other types of savings accounts, the deposit account, money market account, and certificate of deposit are the three (3) most common. Each one begins with the same fundamental premise: send your money to the bank, and the money will earn interest in return.
However, each type of account rewards you differently. One may pay you more interest than the other. Others may make it easier for you to get the money, which is referred to as “liquidity.” The best savings account for you will be determined by your specific circumstances.
#1. Deposit Savings Accounts
Deposit savings accounts, also known as transactional savings accounts, are the most basic way to save money in a bank or credit union and earn interest on it. These types of savings accounts normally require a small minimum deposit to open, and you can avoid incurring minimum deposit fees as long as you keep it open.
#2. Money Market Accounts
Money market accounts, like bank accounts, allow you to deposit money and earn interest on it. But they might ask for a much bigger initial deposit, and you might have to pay fees if your balance falls below a certain level. On the bright side, the best money market account interest rates often reach 2%.
#3. Certificates of Deposit
Certificates of deposit (CDs) are the least liquid but offer the greatest interest rates. To save money on a CD, get one with a maturity period, often known as a “duration” or “term.” The maturity length might range from a few months to ten years, with longer terms earning higher interest. The best CD interest rates are between 2.5 and 3%.
Savings Accounts Advantages and Disadvantages
Some of the advantages of savings accounts include:
- Safety: Money in a savings account at an FDIC-insured bank or an NCUSIF-insured credit union is protected by up to $250,000 per account owner, ensuring the safety of your savings.
- Growth: Savings accounts are usually interest-bearing, which means you will receive interest on the money you deposit into the account.
- Liquidity: While savings accounts allow you to keep money separate from your regular banking demands, they also allow you to make up to six withdrawals or transfers per statement cycle.
- Organization: Keeping your savings separate from your spending money makes it easy to track your progress, avoid overspending, and gain a better understanding of your entire finances.
Savings accounts have the following disadvantages:
- Higher yields are available elsewhere: The biggest disadvantage is that savings account interest rates may be lower than those on other financial products, however, other investments may be riskier.
- Accessibility constraints: Most financial institutions limit the number of withdrawals or transfers from a savings account to six every statement cycle.
- Loss of purchasing power over time: If the yield on your savings account is less than the rate of inflation, you will lose purchasing power over time.
How to Maximize Earnings from Savings Accounts
A savings account’s average interest rate is low. Fortunately, there are a few options for increasing your earnings:
- Check local and internet banks: Large brick-and-mortar banks rarely provide the profits that these smaller institutions do. Online, challenger banks, often known as neobanks, usually offer the highest rates. They avoid the expenses associated with traditional banks and pass those savings on to their customers.
- Receive a sign-up bonus: Some banks provide cash bonuses when you open new savings accounts. These bonuses might be worth thousands of dollars. It’s worthwhile to keep an eye out for the finest bank account bonuses and to open an account with a terrific bonus and a great rate.
- Look into credit unions: A credit union may be able to provide you with a higher yield than you can find elsewhere. These non-profit organizations are member-owned and normally give reasonable rates and low fees.
- Invest in the power of compound interest: While savings accounts provide liquidity, your money will grow faster if you don’t touch it. A compound interest calculator can show you how little deposits into a savings account may quickly pile up over time.
- Keep an eye out for fees: While some savings accounts offer excellent rates, they come with fees that can reduce your interest rate. Make every attempt to avoid incurring fees on your savings account. Even better, look for an account with few fees.
How Do You Open a Savings Account?
It is simple to open a savings account. The first goal should be to identify the ideal account for your needs. Here are some pointers for selecting the best savings account:
- Consider your savings goals: for example, you may desire to save for an emergency fund or a vacation. Knowing your goal will help you choose the appropriate savings to account for you.
- Shop around—not only at big banks: Online banks, credit unions, and community banks generally charge lower interest rates than large retail institutions. Also consider monthly maintenance fees, minimum balance requirements, and transaction fees.
- Confirm that the account is insured: Verify that the account is insured by the FDIC if it is a bank or the NCUA if it is a credit union.
How you open a savings account will depend on which bank or credit union you go to. A driver’s license or state ID, your Social Security number, address, date of birth, and other personal details are usually required to open an account.
Can you Lose Money in a Savings Account?
You will never lose your savings—up to the FDIC insurance limit of $250,000 per account owner at FDIC-insured banks.
However, due to inflation, the money in your savings accounts may lose purchasing power over time. For example, if someone receives 0.2 percent APY on their savings account and inflation is at 7% per year, they will lose 6.8 percent of their purchasing power in a year. Higher savings rates can help you keep up with inflation.
Determine the appropriate cash level to keep in your savings account. You should always have enough on hand to deal with any emergency. However, you don’t want to go overboard and miss out on the possibility of expanding your investments over time.
How Much Should You Keep in Your Savings Account?
The quantity you keep in your savings account will be determined by your savings goals or how you intend to use the funds. If you set up a savings account to receive excess funds from your checking account, your balance is likely to fluctuate frequently. In contrast, if you are working toward a savings goal, your balance will most likely start low and progressively grow over time.
If you’ve set up your savings account as an emergency fund, financial consultants usually recommend saving enough to cover three to six months’ worth of living expenses, giving you a financial cushion in the event you lose your job, have a medical emergency, or face another money-draining event. However, some analysts advise keeping only a part of your emergency fund in a conventional savings account and switching the rest to a higher-yielding account or asset.
In any case, keep in mind that deposits at banks are insured by the FDIC, whereas deposits at credit unions are insured by the NCUA. If the institution fails, both of these safeguards each account holder for up to $250,000 in deposit balances. This more than covers what most customers have on deposit. If you have more than $250,000 in bank accounts, you should spread your money over multiple account holders or institutions.
How Do you Open a Savings Account?
You can open a savings account by going to a bank branch and bringing your government-issued ID as well as any cash or checks you want to deposit. In addition, you will be required to provide your address, contact information, and a social security number or taxpayer identification number. You may be required to open a checking account as well as a savings account, and there may be a minimum deposit requirement. You can also open a savings account with an online bank.
What is the Main Purpose of a Savings Account?
Because of its safety, liquidity, and interest-earning potential, a savings account is a smart place to put money for a later date apart from your daily spending cash. These accounts are ideal for keeping your emergency fund or short-term savings goals, such as vacation or home repair.
What are the 3 Benefits of a Savings Account?
Savings Account Advantages: Security, Access, and More
What is the Risk of a Savings Account?
Savings accounts are not designed to provide large returns on the money placed in them. One of the disadvantages of savings accounts is that some financial institutions charge fees, which can reduce your returns. For example, if your balance falls below the account’s minimum balance requirement, you may be charged a monthly fee.
What are the 5 Characteristics of Saving Accounts?
The following are the top seven criteria for a savings account:
- Simple transactions.
- Bills Payment.
- The availability of an ATM.
- Internet and mobile banking.
- A debit card.
- Savings interest rates.
- Cross-product benefits.
Conclusion
One of the easiest ways to earn interest on your money is through a savings account. They provide better interest rates than traditional checking accounts while also making it simple to spend and withdraw funds. Savings account rates, on the other hand, are substantially lower than other investments and do not keep pace with inflation.
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