What is a savings account?

You earn interest just for leaving your money in a savings account, but there are limits on making withdrawals

Derek Silva

Derek Silva

Published October 23, 2018

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KEY TAKEAWAYS

  • You can only make six transfers in or out of a savings account each month, excluding transactions at an ATM or in person at a branch

  • Savings accounts require a low minimum balance to open but those with higher interest rates may require higher account balances

  • Certificates of deposit (CDs) and high-yield savings accounts have the highest interest rates

  • As long as you use an accredited bank, your savings are insured up to $250,000 if a bank goes out of business

A savings account is a type of bank account where you can leave your money to access it later. You can deposit and withdraw your money if you want, which makes a savings account a type of deposit account.

The main feature of savings accounts is that a bank or credit union usually pays interest just for depositing money and leaving it there. The interest rate for a savings account is usually expressed as its annual percentage yield (APY).

Large banks and credit unions have interest rates as low as 0.01%. You will earn very little at that rate, so look for an account with 1% interest or more. High-yield savings accounts, which are usually available from online banks, can have APYs of 2% or more.

Savings accounts may require a minimum deposit to open and then you may need to maintain a minimum account balance. There is also a legal limit of six transfers in or out of your account each month. This doesn’t apply to ATM withdrawals or transactions you make at a branch in person, but it does include all online transfers. Consider a checking account if you need to move money more frequently.

In this article:

Types of savings accounts

There are multiple types of savings and deposit accounts, and which one you should consider depends on your situation. It may even be a good idea to have more than one type of savings accounts.

For more on how to open any of these accounts, see our guide on how to open a bank account.

Interest ratesMinimum deposit to open accountLiquidityOther considerations
Traditional savings accountAs low as 0.01% from large banksUsually low or no minimumHighLarger banks usually offer insignificant interest rates
High-yield savings accountAround 2% or even higherUsually low or no minimumMediumUsually available from online banks
Money market account (MMA)Often comparable to high-yield accountsSometimes $10,000 or moreHighMay only pay interest if you stay above a minimum account balance
Certificate of deposit (CD)Sometimes 3% or more for multi-year term lengthsOften a couple hundred dollars or moreLowLonger terms offer the highest APYs

How much interest can you earn? Use our savings calculator to find out.

Certificate of deposit

Certificates of deposit, or CDs, differ from standard savings account because you agree to leave your money in a CD account for a specified length of time, called the term. CD terms usually range from a few months up to five years, but some places have terms as short as one week and as long as 10 years.

In exchange for agreeing not to withdraw your money before the end of the term, banks usually offer much higher interest rates for CDs than they do for standard savings accounts.

At the end of your term, you receive your original money plus the full interest payment, and you can withdraw it or move it to another account. If you make a withdrawal before the end of the term, you will pay an expensive early withdrawal penalty.

Learn more about whether CDs are worth it for you.

Money market account

Money market accounts, or MMAs, usually have a higher APY than standard savings accounts, but they usually require a larger initial deposit. You may also need to maintain a higher account balance in order to continue getting a high interest rate.

Some money market accounts allow you to write checks, but they still have a limit of six transactions (including checks you write) per month.

Also note that money market accounts are not the same thing as money market funds, which are a type of investment and don’t have guaranteed returns.

Deposit account

Deposit account is a general term that includes any account where you can deposit money and then withdraw it if you need it. The savings accounts we’ve mentioned above are all types of deposit accounts. However, there are also some deposit accounts that aren’t savings accounts. The best example is a checking account.

A checking account allows you to deposit money, but it isn’t designed as a place to leave your money. It’s meant to give you high liquidity so that you can withdraw as much of your money as you want and as often as you want. Checking accounts are a type of transaction account.

What type of savings account do I need?

There are two major considerations when choosing a type of savings account: how much money you want to deposit and how likely it is that you will need to withdraw the money.

Some account types offer better interest rates and more features if you have a higher account balance. It’s also easier to withdraw money from some account types. How easy it is to withdraw money is called liquidity. High liquidity means you can withdraw money quickly and whenever you need it. Having low liquidity means it’s harder to withdraw your money at any given time. Accounts that are less liquid usually have higher interest rates.

If you plan to put your money in an account and leave it (or most of it) there to earn interest, an account with low liquidity, like a CD, is probably fine. Standard savings accounts offer more liquidity, but there is also a limit on how many transactions you can make each month. Your best option if you want to withdraw money frequently is a checking account.

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Savings accounts vs checking accounts

Savings accounts usually offer interest, and so they’re best if you plan to leave most of your money untouched in the account. Many checking accounts offer little or no interest, but they also don’t limit how many transactions you can make. That makes checking accounts a good option for the direct deposit of your paycheck and for paying monthly bills.

Checking accounts also allow you to make payments straight from your account using personal checks or a debit card. Some savings accounts come with an ATM card that allows you to withdraw money from an ATM, but not to make purchases.

Many banks allow you to link a savings and checking account, which allows you to easily move funds between the two. That means you could direct deposit money in a checking account, use the money to pay your bills, and then move the remaining balance to your savings account every month.

Learn more about checking accounts versus savings accounts.

Is a savings account safe?

Banks rarely fail but even if your bank does, your savings are safe because all accredited banks (which includes most banks) are insured through the Federal Deposit Insurance Corporation (FDIC).

The FDIC is a federal agency that insures your savings for up to $250,000 per bank. So if you have $250,000 in a savings account at one bank and $250,000 at another, all $500,000 is covered. The FDIC also insures your money in case of a bank robbery or natural disaster. It does not insure investment accounts, like a traditional IRA or Roth IRA.

Accounts the FDIC covers:

  • Savings accounts
  • Certificates of deposit
  • Checking accounts
  • Money market accounts
  • Cashier's checks, money orders, and other official bank checks

Accounts the FDIC does not cover:

  • Stock investments
  • Bond investments
  • Mutual funds and exchange-traded funds (ETFs)
  • Life insurance policies
  • Annuities
  • Safe deposit boxes or their contents
  • U.S. Treasury bills, bonds, or notes (though the U.S. government insures these)

Credit unions get the same insurance, but through the National Credit Union Administration (NCUA).

What about online banks?

Opening an online savings account is just as safe as opening one at a brick-and-mortar bank. These banks dedicate significant resources to protecting your money and personal information. Online banks have few or no physical locations.

Note than online banks are different from the mobile banking (think phone apps) and online banking services that most banks offer. (Even physical banks may manage their operations digitally.) All account management is done online or through an ATM. You can also find all the same types of accounts at online banks.

If you want to learn more, here are the pros and cons of online banking.

How interest works in a savings account

To understand how interest works in a savings account, there are three useful things to understand: simple interest, compound interest, and APY. A simple example is the easiest way to explain these three things.

Let’s say you have $100 in your savings account and it’s earning 1% interest. You will earn $1 from interest — 1% of $100 — and your account balance will be $101 at the end of your interest cycle. (Most banks pay out interest monthly, but some do it daily, quarterly, or annually.) This is how simple interest works.

If you leave the $101 in your account for another month, you will now earn 1% interest on $101 instead of on your original $100. Earning interest on the interest that you’ve already earned is called compound interest (also called compounding interest).

Now imagine you leave money in your savings account for an entire year, and you get interest payments at the end of each month. Because of compounding interest, the amount you earn from interest at the end of the year is more than just 1% of your original $100.

The amount you actually earn, if you leave your money untouched for a year, is the annual percentage yield, or APY. The APY factors in compound interest. Banks usually report the interest for a savings account as APY (because that's higher than the simple interest rate). So if a bank says that an account earns 1% interest, that usually means the APY is 1% and the simple interest rate is slightly lower (about 0.995%). A 2% APY is an interest rate of 1.98%.

People use APY and interest rates interchangeably, even though they are technically not the same. You will never earn an account’s APY unless you leave money untouched in the account for a full year.

What is a good interest rate?

As of November 2019, the average national interest rate for savings accounts is 0.09%. Large banks and credit unions usually low interest rates. Many large banks offer 0.01% interest. That means you earn just one cent of interest for every $100 in your account.

High-yield savings accounts have become popular recently and they offer rates around 2%. At some points, rates may even go above 2.5%. But even if you only earn 1% interest, that would mean you earn $1 for every $100 in your savings account — significantly more than you get from most banks or credit unions. Most high-yield accounts are available through online banks, which don’t have physical branch locations.

Other types of savings accounts, like CDs, may earn you 3% interest or more. However, those accounts may require you to have higher account balances or to leave your money in the account for a certain amount of time.

APY vs APR

APY may remind you of APR, a similar term that stands for annual percentage rate. APR is a measure of how much interest you owe on a loan or a line of credit. You will see APR used for used for credit cards, mortgages, and auto loans, but it isn’t related to savings accounts.

How banks can afford to offer interest

The money that banks earn from the interest payments on loans allows them to offer interest to their deposit account customers. Online banks can also afford to offer higher interest rates because they don’t have the additional cost of maintaining physical locations.

In general, banks and credit unions make most of their money by lending money to customers, especially through loan and mortgage interest. However, they can only give you a loan if they have the funds to do so. The money customers deposit in savings accounts helps banks have funds for loans. To encourage more customers to open savings accounts, one thing banks do is offer interest on your deposits.

Many banks also earn money through various fees. For example, they may charge a maintenance fee or monthly service fee, which you pay just for having an account. If you dropped below your account’s minimum balance at any time during your statement cycle (usually a calendar month), you could pay a fee. Most banks charge ATM fees for withdrawing through an ATM not affiliated with their network. Overdraft fees from checking accounts also make banks billions of dollars annually.

Learn more about how you can avoid common fees.

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Having a savings account is half of the financial protection battle. Life insurance is the other half.

Your savings account can help you save money, but a life insurance policy will keep protecting your family when you're no longer around.