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What Is a Savings Account & How Does It Work?

November 10, 2021

A savings account is a deposit account that’s designed to hold money a person needs for a later date. But because these accounts are liquid, a savings account holder can access their funds anytime.

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When the average person opens a bank account, they often don’t just open one—they open two: a checking account and savings account. A checking account is usually reserved for routine money tasks, like depositing paychecks and drawing from to pay bills, while a savings account is where people usually hold money for short-term money goals. 

Savers can deposit money anytime into savings accounts, and they’ll usually benefit from federal deposit insurance and may even earn a modest amount of interest on their deposits. Find out how these accounts work and how to find the right one for you.

What is a savings account?

A savings account is a deposit account that’s designed to hold money a person needs for a later date. But because these accounts are liquid, a savings account holder can access their funds anytime. Most savings accounts are government-insured, which means the money is safe against bank failure, and may even pay interest on deposits. All of these factors make savings accounts a place to keep money for short-term goals, like an emergency fund or a down payment on a house.

When someone is ready to open a savings account, they’ll have options at most credit unions, banks, and online financial institutions. While the saver can deposit money into these accounts anytime, their financial institution might restrict how often they can make withdrawals. Some impose a limit of six withdrawals per month, while others may allow more withdrawals but charge fees for them. (The withdrawal limit can be beneficial if someone needs an extra reason to leave their money untouched.)

Savings accounts are different from checking accounts, which are designed more for day-to-day use. Checking account holders can write checks, make cash deposits, and withdraw money at an ATM or a store using a debit card. Brokerage accounts also differ from savings accounts because they provide a way to buy and sell securities such as stocks, bonds, and mutual funds.

Why open a savings account?

There are several reasons one might consider opening a savings account.

  • They’re insured. If a bank is insured by the Federal Deposit Insurance Corp., or FDIC, then its savings accounts are insured for up to $250,000 in the event of a bank failure. The National Credit Union Administration, or NCUA, provides similar insurance for deposit accounts at credit unions.
  • They’re liquid. Savings accounts provide more liquidity than some products, like retirement accounts, real estate, and individual stocks and bonds. Account holders can typically withdraw money from the savings account anytime, although they might pay a fee if they go over the six-withdrawal limit.
  • They usually pay interest. Interest provides a consistent, passive return on the saver’s money.

Different types of savings accounts

Generally, a savings account is any account that allows account holders to add funds, earn interest, and withdraw money with some limits. But they can be further classified by their interest rate structure and other features:

  • Standard savings accounts. These are basic savings accounts usually offered at brick-and-mortar banks and credit unions. Account holders usually pay monthly maintenance fees, must maintain a minimum balance, and receive a lower annual percentage yield (APY).
  • High-yield savings accounts. Usually available at online institutions, these offer an above-average APY with little or no account fees. However, account holders may need to meet certain conditions to receive these terms.
  • Money market accounts. These combine features of checking and savings accounts. Account holders usually get above-average interest rates, can write checks, and can make withdrawals and purchases using a debit card.

There are also different ways to define who can use the savings account:

  • Individual account. These are owned by a single person. No one else can use the account, with the exception of a power of attorney.
  • Joint accounts with rights of survivorship. These are owned by two or more people. If one of the owners dies, the remaining funds are given to the living account holder(s). The government guarantee increases accordingly, so, for example, two account holders receive $500,000 of FDIC or NCUA insurance.
  • Payable on death (POD). In this arrangement, a specified beneficiary receives the funds from a savings account when the owner dies.
  • Uniform Transfers to Minors Act/Uniform Gifts to Minors Act (UTMA/UGMA). This provides a way for an adult to open a savings account for a minor without setting up a trust or paying taxes beyond a certain amount. The adult oversees the account until the child reaches age 18 or 21, depending on the state.

Choosing a savings account

When an individual wants to open a savings account, they can shop around at different banks, credit unions, and online institutions. Each account may have a different APY, fee structure, and terms and conditions. People typically focus on these savings account features:

  • Annual percentage yield. APY shows how much interest the account earns each year. Savings accounts usually have a variable APY, which means it can change over time. A higher APY can help account holders earn more money, but they might have to follow certain terms to keep that rate.
  • Minimum balance. Account holders may need to keep a certain amount of cash in the savings account to earn the published interest rate or avoid monthly fees.
  • Initial deposit requirements. Individuals can usually open a savings account with as little as $25 to $100. In some cases, they won’t need an initial deposit at all.
  • Monthly maintenance fees. Some financial institutions charge a monthly fee just for keeping a savings account open, which could wipe out any money earned on interest. But some institutions waive the fee if certain requirements are met.
  • Easy withdrawals and deposits. For the ability to transfer or withdraw money easily, individuals want features such as a wide ATM network, the ability to use a debit card, and digital tools like payments app Zelle. They also check how often they can make withdrawals before a penalty kicks in.
  • Deposit insurance. Depending on where they keep their savings, individuals check whether the account is FDIC-insured or NCUA-insured. Deposit insurance guarantees they’ll get their money in the event of a bank failure, as long as they’re within the insurance limits and guidelines.

Type of institutions offering savings accounts

Individuals can open a savings account at a brick-and-mortar bank or credit union or go digital with an online institution. Here are the main differences:

  • Online banks and credit unions generally have lower overhead costs, so they may offer higher interest rates on deposits and charge fewer fees. These conveniences come in lieu of in-person support, though.
  • Banks often have wider networks of in-person branches and ATMs, and they may adopt new technology and tools more quickly than credit unions. They may pay lower interest rates and charge more fees.
  • Credit unions typically provide higher interest rates on deposits and stronger customer service. However, individuals typically need to join the credit union before opening an account.

How to open a savings account

Opening a savings account is usually quick and easy. Here are the steps typically involved:

  1. Contact the financial institution. Once an individual has chosen the bank or credit union that fits their needs, they contact them about opening a savings account. Applications may be done online, by phone, or in person.
  2. Gather information. Individuals likely need a government-issued form of identification, such as a driver’s license or passport, along with their name, address, phone number, date of birth, and Social Security or tax ID number.
  3. Select the ownership category. If an individual is opening the account with another person, they’ll need to provide their identification and personal details, too.
  4. Read the disclosure. This document includes details like the saving account’s fees, interest rate, minimum balance, initial deposit, and terms and conditions.
  5. Make an opening deposit. If the account requires one, an individual can usually fund it with cash, a check from another account, or an online money transfer.
  6. Submit the application. An individual may get a confirmation within minutes when they apply online or in person, but it can take a few business days for the bank to verify their information and open the account.
  7. Fund the account. Account owners can usually move money to their savings account by linking an existing checking account using the routing and account numbers. Then they can decide whether to set up direct deposit or automatic transfers.
  8. Make withdrawals. Account owners can usually send money to another account by logging into an online account or app, then setting up a transfer. It also might be possible to withdraw money at an ATM or in person.

FAQs about savings accounts

How frequently do savings account interest rates change?

Savings accounts usually have variable interest rates, which means they can change at any time. Banks and credit unions often increase or decrease rates during economic changes, such as when the Federal Reserve’s Open Market Committee (FOMC) adjusts the federal funds rate. The FOMC holds eight scheduled meetings per year, so an individual might notice changes after these meetings. However, a bank can also change an interest rate anytime for marketing purposes or to address other internal needs.

What are the typical fees associated with a savings account?

Savings accounts may charge out-of-network or foreign ATM fees, wire transfer fees, or fees for purchasing a cashier’s check or official bank check. Account holders may also pay a fee if they close the savings account and withdraw their money before a certain time, usually three to six months. Monthly maintenance fees are also common, but the financial institution may waive the fee if a minimum balance is kept in the account.  

Do I have to pay taxes on my savings account?

The money an individual contributes to a savings account isn’t taxable (because they’ve already paid income tax on it), but the interest earned is taxed as ordinary income. A financial institution should send a Form 1099-INT if more than $10 in interest was earned during the previous tax year. Account holders can use the information on this form to report the interest on their income tax return. If they earned less than $10 in interest from their savings account, they won’t receive the form, but they’re still required to report the income and pay taxes due on it.

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