Many people have their paycheck deposited into a checking account or deposit their money into these accounts manually. Checking accounts are designed to manage income and outgoing money with ease, but sometimes, they lack a few key features that are important for money management, including the savings aspect. A savings account, on the other hand, pays you interest if you put your money into the account and leave it there.
Why Is a Savings Account a Better Option?
There are several reasons why you should have both a savings and a checking account. They should function for different goals for you.
For example, you should use a checking account for:
- Paying bills
- Making purchases
- Handling emergency expenses
- Depositing your paycheck
- Depositing other money you receive
Your savings account has a few different goals:
- Serving as your long-term vehicle for building value
- Paying you interest on your money over the long term
- Providing you with a way to manage an emergency fund while still building interest
- Keeping your money separate to ensure you have a backup reverse in place
- Helping you to manage larger investment goals as well as larger expenses over time, such as a down payment on a mortgage
However, there are different types of savings accounts. It is also important for you to choose one from a bank that keeps your money protected from risk.
How and Why Savings Accounts Earn Interest
The key feature of a savings account is that it earns interest. This is money paid to you by the bank or financial institution in which you deposit your funds. When you place money into your savings account, the banks can use those funds to invest and grow their value. Most of the time, the bank pays you a set interest rate, perhaps half of a percentage. However, the bank itself can earn more than this by investing your money.
Because savings accounts hold money for a longer period of time, they typically are safer funds for the bank to use for investment. It’s important for you to know that your money is protected. Under federal laws, the money in your account has protection even if the bank’s transactions and investments do not go well.
About Savings Account Interest
When choosing a savings account, it is important for you to know how the interest is calculated for you. This will range widely from one bank to the other based on the type of the account. In some cases, the interest will compound over a set number of days. Some accounts with have compound interest that is based on monthly or quarterly figures. Some are annual. When considering the overall cost benefits – and leaving everything else equal – daily compounding rates are going to provide you with the best outcome. The more often the compound rate is paid to you, the more you will learn.
Here is a simple example. If you have $10,000 in your savings account and the account is earning 1 percent interest, consider these outcomes. If you have an annual compounding rate, that means it will compound just one time a year. In this case, you make $100 that year. However, when you break that down over a shorter period, your earning potential increases.
Let’s say you break that into a daily compound interest rate. That means that one percent is now divided by 365 days for the year, and that is the interest you earn each day. Now, you are earning slightly more, perhaps about $100.50 a year. That is a small amount of different, but it can add up significantly over time.
What They Pay You
While compounding rates is one of the things you need to consider when choosing a savings account, it is also important for you to choose a lender offering you a good rate. Most banks post the rate of pay of their savings accounts right on their website. Confirm what the rate is before you open an account. This is the biggest factor in determining which account is best for you.
As you do so, though, learn about any fees that apply with the account. Many savings accounts have no fees – and that means what you earn in interest in is all you will see change in your account. No fees are the ideal situation. If there are fees, remember that they are cutting into anything that you earn. As a result, that small amount of interest may not be worth it. Look for a bank that keeps all of their fees low to keep your costs low.
It’s Not Just about the Earning Ability
While there are many reasons to use savings accounts, they are not always just about the interest you will earn. Often, the interest paid on savings accounts is very low. And, while this is a very safe investment strategy because of the federal protections on these accounts, it is still not the primary reason to use savings accounts.
Rather, the reason to do so is to create a nest egg for yourself. There are numerous other forms of investments out there – many that grow in value much faster. Yet, having money in a savings account provides you with financial stability. If you become ill and cannot work for several months, you have these funds to support you. If you lose your job, you have this cash on hand to keep paying the bills, including the mortgage and credit card debt. For this reason, view the value of a savings account as a tool to help you hedge against risk and to maintain financial stability.
Also, of course, it is much safer than trying to stuff money into your mattress. Your money in a savings account remains accessible to you if you need it – often right through the ATM. Yet, your primary goal is to keep those funds in your savings account for a rainy day, not to use them for daily purchases or to pay bills. It can make a big difference in the long term in these situations.
Navigating Savings Account Features
Savings accounts are very simple to use, but they do have several key features. It’s important for you to compare financial institutions and the terms of any savings account to determine the specifics for your account. Here are a few things you should learn.
Transactions Are Limited
Federal law places restrictions on how many times you can withdraw money from your savings accounts. Because savings accounts are designed to provide a way to save money, laws encourage people to leave the funds in the account and to restrict how many times they access them. Federal Regulation D puts in place these rules.
You are able to make as many deposits into your account as you would like to. However, you are limited to making no more than six withdrawals from the account in any given day. One of the key reasons this law was put into place was to limit money laundering threats. This type of rule applies to most types of savings accounts, as well as money market accounts.
If you need to make more than six transactions, financial institutions and online banking generally allow this to happen. However, there may be a fee charged to you for doing so more than six times per month.
Savings Account Fees
As noted, some savings accounts have fees. For example, some banks require that you maintain a specific amount of money as the bare minimum in order to earn the interest rate paid to you. Accounts fees may also include some types of maintenance fees.
To learn what fees you may be charged, read through all documentation that the financial institution offers to you. This includes the Fee Schedule as well as the Truth-In-Savings Disclosure document. These are legal documents required to be given to you at the time of opening an account. They can also be explained to you in detail if you have questions.
As noted, an excessive withdrawal fee is one of the most important to learn about. These fees can be significant and may apply to withdrawing money more than six times per month, but also when you withdraw more from the account that the required minimum balance.
Additional Fees You May Incur
Savings accounts may have additional fees associated with them. This may include, for example,
- An account closing fee associated if you close the account within a certain number of days from opening it; this generally applies to three to six months after opening the savings account
- Inactivity fees are common with savings accounts there is no deposit added to the account; these fees range widely in requiring this, but it can occur in situations where there are minimum deposits required due to the terms of the savings account
Be sure to read through all fees to know what to expect. You should also consider speaking to your bank if you notice transactions on your account that you were not expecting.
Account Linking
One of the key features of some of the best savings accounts is that you can link them to your other financial accounts. For example, you can link them to your checking account within the same financial institution. Because of this feature, you can easily transfer money between your accounts, usually with a simple transaction right on your bank account’s website or within your mobile app, if available.
Some of the best account linking tools also allow you to set up automatic deposits. For example, you can schedule a withdrawal from your checking account to occur every other week, perhaps when your paycheck hits the account. The money is automatically deposited into your savings account. This type of automatic investing can help to make investing consistent and allows you to maintain the best possible savings habits.
Yet another benefit of linking is that you can cover your checking account from errors. For example, some financial institutions allow you to link your checking account to your savings account in case of an overdraft. If you accidentally withdraw too much from your checking account, the bank will automatically transfer funds from your savings account into the checking account. In doing this, it can help to reduce the risk that a transaction is denied. Be sure to learn about the costs applicable here. Many times, fees apply especially if the transfers happen many times. Overdraft transfers like this also apply towards that six withdrawal maximum associated with savings accounts.
Why Should You Have a Savings Account?
Most people will find that a savings account is one of the best investments they can make in their financial health. Take a look at some of the benefits this type of account can offer to you.
Your Money Remains Protected
Under U.S. law, the money you deposit into a savings account with a recognized financial institution, including most banks is protected by the Federal Deposit Insurance Corporation. If you have a credit union savings account, it also has protection. This is done under the National Credit Union Association.
This is a form of insurance that gives you peace of mind knowing that the money in your account is protected from loss. As of now, this type of insurance protects up to $250,000 in your account. It covers every account you open for this amount. It covers you from any instances in which the money is at risk, including if the investments the bank makes using your funds are not effective.
They Are Easy to Use and Access
Savings accounts are very accessible. They tend to be the ideal choice for those who are ready to start savings, requiring very little investment to get started. Banks will allow you to open a savings account as long as you have basic identification. There are no credit checks or any other type of difficult process.
Once your funds are in your account, you can continue to use it for any needs you have within the limits. Keep in mind that you can access your savings account through visiting a bank branch, using an ATM, and through mobile apps, if the bank or credit union offers one. You can also schedule electronic transactions into your savings account, such as having your paycheck automatically deposited into the account.
Bottom Line
It’s also important to know that, compared to other investment options, savings accounts have some limits. For example, the interest rate paid to you is going to be lower than most other types of investments such as buying stocks or buying bonds. That’s because of the protections in place. You can also face some limits if you open an online-only savings accounts – accessing your funds may be a bit more difficult in these cases.
