What Is A Savings Account And How Does It Work?

Banking Basics

Simply put, a savings account is a type of bank account that helps you grow your money. It can be used to build your safety net or save for financial goals.

But how do they work? And what do you need to get started?

Keep reading to find out.

What is a Savings Account?

Let’s first discuss the difference between a savings account and a checking account.

A checking account is a bank account that’s ideal for paying bills or daily expenses. It comes with a debit card and check-writing privileges.

On the other hand, a savings account lets you save money that you’re not planning on touching right away. It’s a safe place to keep your hard-earned paycheck that isn’t under your mattress or in a drawer.

More importantly?

Savings accounts give your money the opportunity to grow because they earn interest. Most checking accounts don’t earn interest, and those that do typically earn less than a savings account at the same bank.

You can open a savings account at your local bank, credit union, or through an online bank. You’ll need to make an initial deposit to open the account – typically between $25 – $100.

Now you’re probably wondering:

But is a savings account actually worth it?

Yes, because savings accounts protect your money.

Storing your money under your mattress or in a piggy bank is risky business. Your savings could get stolen, lost, or put through a natural disaster like a flood or house fire.

Not good.

Savings accounts (both through online banks and in-person) are safer because the vast majority of them are federally insured by the Federal Deposit Insurance Corporation (FDIC). Savings at credit unions are insured by the National Credit Union Administration (NCUA). This means that in the rare case the bank or credit union goes under, your money is guaranteed.

Did You Know… Both the FDIC and NCUA insure your deposits up to $250,000. This insurance covers several accounts including checking, savings, and money markets.

How Do Savings Accounts Work?

In return for depositing your money with the financial institution, you’ll earn interest each month. The amount of interest you earn yearly is called the APY, or annual percentage yield.

APYs vary from bank to bank and month to month, but often, online banks provide higher interest rates than traditional banks.

Besides the APY, there are some things you’ll consider when opening a savings account:

  • Minimum balance requirements. This is the minimum amount of money you have to keep in your account.
  • Account fees. This includes ATM fees, low balance fees, and monthly maintenance fees.
  • Convenience. Do they have a good online banking experience? Or a large network of ATMs near you?

It’s important to note that savings accounts come with six withdrawal limits per month.

Tip: You can find APYs as high as 1.00% with online banks like Chime, which is much better than the national average of 0.05%.

How Much Money Should You Keep in Your Savings Account?

Financial experts recommend you have an emergency fund of three to six months’ worth of expenses. To determine what that amount is for you, you’ll start by adding your monthly essentials.

Your monthly necessities are things such as:

  • Housing
  • Utilities
  • Transportation
  • Groceries

Once you add your essentials, then you’ll multiply it by the number of months you’d like to save for.

For instance, if your essentials cost you $3,500 per month then you’ll save anywhere from $10,500 to $21,000 in your account.

($3,500 x 3 months = $10,500)

But that’s not all.

You can also use your savings account to save for vacations, birthday gifts, or large purchases like a car.

Tip: Financial experts recommend creating sinking funds to save money. A sinking fund is money you set aside each month towards a future expense or purchase.

Is There More Than One Type of Savings Account?

There are several types of savings accounts and each one has its perks. For example, you might earn more interest from one than another. Others might let you access your money easier.

The four most common savings accounts are traditional, high-yield, money market, and certificates of deposit (CDs).

They all share one common principle:

Store your money in them and it’ll earn interest in return.

But how do these savings accounts differ, you ask?

Let’s break it down.

1. Traditional Savings Account

Traditional savings accounts are what you commonly think of when you picture your local bank. They allow you to earn interest on your money, but they pay lower rates than high-yield accounts.

They come with lower interest rates because they allow you to access your money more easily.

While you’re limited to six transactions a month, certain things don’t count against that limit. Transferring money from your savings account to your checking at an ATM doesn’t count against that limit, for example.

Traditional savings accounts are good for you if:

  • You prefer banking locally or;
  • You want to save money but aren’t concerned about getting the highest APY.
Did You Know… Studies show that people who use a zero-based budget save 18% more money than those who don’t.

2. High-Yield Savings Account

High-yield accounts offer higher APYs compared to traditional accounts.

Online banks tend to offer high-yield accounts that beat the APYs at brick-and-mortar banks.

Why?

Because they have fewer overhead costs so they’re able to pass those savings onto you. Besides better rates, online banks tend to charge lower fees.

High-yield savings accounts are good for you if:

  • You value little or no fees
  • You want higher APYs so your money earns more

3. Money Market Accounts

A money market account is a savings account with a debit card and check-writing privileges.

The catch?

They usually require you to make a larger initial deposit. You could also get hit with fees if your balance drops below the minimum requirement.

The upside is that money market accounts can offer higher rates than traditional accounts, and sometimes even outearn high-yield savings accounts.

Important: When looking at money market accounts, make sure you check the initial deposit and minimum balance requirements to ensure you qualify.
Money market accounts are good for you if:

  • You want to access your funds easily with a debit card or checks
  • You value high APYs so you can grow your balance
  • You don’t mind the potentially higher initial deposit

4. Certificates of Deposit (CDs)

CDs come with the highest interest rates but the lowest accessibility.

Opening a CD is similar to other savings accounts. The main difference is that you’re agreeing to allow the bank to hold your money for a specified time which is called a “maturation period.”

This term can last anywhere between six months to five years – which you’ll agree on before opening the account.

At the end of the maturation period, you can either withdraw your money or allow the bank to reinvest it into a new CD with the same term.

Reinvesting allows your money to grow through compound interest. So you’ll earn money on your original deposit plus its interest.

You can withdraw your money before the CD term expires, but you could incur hefty charges for doing so.

Tip: Online banks tend to offer the best CDs rates, as high as 3.10% for a 5-year term.
CDs are good for you if:

  • You have long-term savings goals and don’t plan on touching that money
  • You value higher interest rates and low risk
  • You like the idea of reinvesting your CD for compound growth

How to Open a Savings Account

Ready to take the next step towards saving money?

Opening a savings account is simple. First, you’ll need to decide which savings goal you’re trying to reach. This will determine what type of savings account suits your needs.

Secondly, you’ll need to gather the necessary documents. This includes:

  • Government-issued ID
  • Your social security number
  • Your address

Finally, you’ll be required to fund your new account with an initial deposit. This amount will vary from bank to bank, but it’s typically between $25 – $100.

How to Get the Most Out of Your Savings Account

Want to boost your savings? Follow these tips:

  • Take advantage of bank sign-up bonuses. Many banks offer introductory bonuses for new customers. These bonuses usually range between $100 – $500.
  • Automate your savings. Ever heard of the “pay yourself first” principle? The idea is to have an automatic amount deducted from your paycheck each month. This makes saving easy because you don’t have to think about it.
  • Stick with a bank with low fees. Don’t let your bank cut into your savings. Online banks like Chime are a good option if you want no fees or minimum balance requirements.
  • Use mobile banking to be aware of your spending. Oftentimes, we have no clue how much money passes through our wallets every day. Vow to login to your mobile app daily so you can track your expenses.

Conclusion and Key Takeaways About Savings Accounts

To recap, a savings account is a type of bank account that helps you save and grow your money.

They’re a much safer place to store your money than under your mattress or piggy bank – which can leave your funds vulnerable to thieves or natural disasters.

They’re also great tools to help you reach your financial goals. Whether you want to save for a house or build your emergency fund, a savings account is a good place to start.

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