What is a savings account?

The cash in your savings account gains interest just for sitting there. You can also withdraw it, transfer it, or sometimes write checks against it.

Zack Sigel 1600

Zack Sigel

Published October 23, 2018

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When you deposit money in the bank, you have the option of putting it into a checking account or a savings account. A checking account lets you access and use the money with ease, such as when withdrawing cash or paying for things directly. A savings account has slightly more restrictions on accessing your money, but in return for these restrictions, the bank will pay you interest.

You can use the cash in a savings account much like cash in a checking account: withdraw it, transfer it to other checking or savings accounts, and write checks against it. As with other types of bank accounts, savings accounts are insured up to $250,000 by the Federal Deposit Insurance Corp. (FDIC), a government agency. (Deposit accounts at credit unions are insured by the National Credit Union Administration for the same amount.)

Many people use their savings account as a rainy-day fund for emergencies and other unexpected expenses. While interest rates are generally between 0.01% and 2% for a basic savings account, that’s still additional money in the bank simply for parking your money there. Your interest returns are expressed as the annual percentage yield, or APY.

In addition to the basic deposit account, there are several different types of savings accounts, such as certificates of deposit and money market accounts. However, savings accounts are different from investment accounts, which have a potentially higher rate of return but also some level of risk.

Read on:

Types of savings accounts

When determining what type of savings account you need, you must decide what you’re using the cash for. For example, if you’re using the account as an emergency fund, you’ll need the cash faster; if you just want to earn interest, then you don’t need the money as fast. The ease with which you can withdraw or spend the money in the account is called liquidity.

Deposit account

With the deposit account, you put money into your savings account and let it sit there while it gains interest. You can fund the account with cash, a transfer from your checking account, or from splitting your direct deposit into both your checking and savings account. Deposit accounts have the most liquidity.

Certificate of deposit

Certificates of deposit, or CDs, have low liquidity. That’s because you purchase a CD for a length of time, often a span of months or years, at the end of which you receive the full interest return.

Money market account

Money market accounts may have a higher APY, but they may also require a much larger initial deposit. They’re also about as liquid as a deposit account. However, note that money market accounts are not the same thing as money market funds, which are an investment and don’t have guaranteed returns.

Savings accounts vs checking accounts

Savings accounts and checking accounts can complement each other, but they’re also different in key ways. Most importantly, checking accounts typically don’t gain interest, and when they do, the APY is almost negligible. Because savings accounts gain interest, banks and credit unions may limit how you use the account.

Learn more about checking accounts versus savings accounts.

Using the cash

The checking account can be used to make purchases directly, using your debit card. You can’t get a debit card for your savings account, but you can link your checking account’s debit card to your savings account. Some types of savings accounts come with an ATM card, which can be used to withdraw cash from an ATM.

Unlike checking accounts, there is a limit to how many transactions you can make with the savings account each month. This limit is six, and it includes such transactions as spending money using a linked debit card, writing checks, using the card’s overdraft protection, and making preauthorized transfers like autopay. However, ATM and in-person withdrawals don’t count toward this limit. Exceeding the limit can result in fees.

Minimum balances

Both checking accounts and savings accounts usually require you to maintain a minimum balance, although the amount will vary between banks and savings account products. Not meeting this minimum balance could result in fees. Other ways to avoid the minimum-balance fee include setting up direct deposit for your deposit accounts or linking a checking account with the same bank.

Overdraft protection

A feature of some savings accounts, especially when you open the savings account with the same bank with which you have your checking account, is overdraft protection. This means that if you spend more of your checking account than you have, then the excess can be taken out of your savings account. Although you may be charged a fee for this service, the fee should be lower than what you’d pay for overdrafting without overdraft protection.

Earning interest on your savings

Savings account interest can be as low as 0.01% of your balance to as high as 3% of your balance or more, expressed as the APY. Less liquid accounts, like CDs, typically reward you with much higher interest rates. A high-yield savings account usually earns about 1% to 2% in interest.

Online banks usually offer higher interest rates than brick-and-mortar banks, but it pays to shop around until you find interest rates most favorable to your savings strategy. Fiona, a partner of Policygenius, can help you compare savings accounts online until you find the best interest rate.

Interest on savings accounts is compounding. That means the interest is added to the balance, and you can earn interest on the sum. If you gain $10 in interest one year on a $1,000 balance, then the next year you earn interest on the resulting $1,010.

The APY may remind you of APR, a similar term that stands for “annual percentage rate” used for credit cards, mortgages, and auto loans. APR is a measure of how much interest you owe on a loan or a line of credit, and you won’t see it used in relation to savings accounts.

How to open a savings account

Follow these steps to open a savings account without breaking a sweat:

  • Research interest rates. Interest rates vary by bank and by type of account, so find which ones offer the most yield for your money.
  • Choose a bank or credit union. You don’t have to open the account with the same financial institution as your checking account, but it could make things easier. Go with a name you trust, and be sure to research the firm’s fees and interest rates.
  • Submit your information. You can do this either online or at a brick-and-mortar location. Typically, you may need to submit two forms identification including at least one with a photo ID.
  • Make your initial deposit. Your account won’t be active until you’ve deposited at least the minimum amount of cash.

Note that if you’re under 18, your parent or guardian will have to be the custodian or co-owner of the account. You can take sole control of the account when you turn 18.

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Looking to save?

Policygenius' partner Fiona can help you compare current savings accounts and money market account offers.

How much money to keep in your savings account

The money in your savings account is guaranteed. You’ll never lose money because of a bad investment or a downturn in the market. And if there’s another economic crisis, such as the Great Depression or the recession of the late 2000s, your money is backed by the FDIC (or NCUA, if you use a credit union) up to $250,000.

For that reason, savings accounts make ideal emergency funds. Although they’re less liquid than checking accounts, the money you make on interest could help you manage an expense like car repairs or sudden medical bills.

You should have a checking account to manage your day-to-day expenses, like bills and loan payments. But stash away about six months of expenses in your savings account in case you lose your job or otherwise struggle to keep paying those bills. It doesn’t cost you anything, as long as you keep up the minimum balance, and you won’t need the money right away if you’ve been keeping up your checking account, too.

Savings accounts vs investment accounts

Investment accounts include financial products like the retirement account you have with your Roth IRA or 401(k), or your stock-trading account brokerage account. Unlike savings accounts, there’s an element of risk involved in investing, and you could even lose your principal – the balance of all contributions you’ve made to the account — if your investments turn out particularly bad.

Investment accounts are also not insured by any government agencies, as savings accounts are. If another financial crisis occurs, an investment account could potentially lose a lot of money. However, investment accounts typically have a much higher rate of return than savings accounts over the long term.

For example, between October 2017 and October 2018, the Dow Jones Industrial Average (DJIA), a commonly used index for share prices of some of the largest companies in the U.S., has returned about 9% on average. But if you bought into the DJIA in January 2018, then you earned little more than 2% on average by October 2018, less than many savings accounts. Based on historical trends, it’s almost certain that share prices will pick back up, but nothing is a given. If that’s too risky for you, then a savings account will provide more peace of mind.

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

Policygenius can help you find a life insurance policy to protect your loved ones.

Policygenius’ editorial content is not written by a certified financial planner or advisor. It’s intended for informational purposes only and should not be considered legal, financial, or investment advice. Consult a professional to learn what financial products are right for you.

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