Introduction to a Savings Account: What It Is & How It Works

ByJulija A.
December 08, 2021

We all probably remember the little piggy banks we used to stash some extra money in. As kids, most of us had that special box we kept spare cash in, especially when we had plans to use it for something particular in the future.

We can liken a savings account to the piggy banks we had as kids, the difference being that our piggy banks generated no interest over time.

As adults, it’s even more important that we have a secure place where we can keep the money we need to achieve certain goals in the future; or something to fall back to on a rainy day. This is where a savings account comes in.

What is a savings account? How does a savings account work? These questions could be running through your mind, but not to worry, they will be answered shortly, as we’ll explain everything you need to know about savings accounts in this article.

What Is a Savings Account?

A savings account is a type of account that allows you to deposit money you’re not planning on using anytime soon while earning interest on your balance over time. It enables you to put some money aside for specific purposes or save toward a goal or project in the future and earn interest while at it.

A savings account is not the same as a checking account that allows you to make frequent withdrawals to pay bills and sort out day-to-day expenses. 

Also, note that a savings account is not the same as a fixed deposit; because while the latter only allows you to withdraw at the end of the specified period, the former allows you to make restricted withdrawals when necessary.

Although savings accounts are mostly used for short-term goals, there are limits to how frequently you can make withdrawals from your account because the longer your money stays in your account, the more interest you earn on the account. Different financial institutions offer different interest rates for their savings accounts; however, these rates are usually not so high.

How Does a Savings Account Work?

Just like most other bank accounts, a savings account can be opened with a financial institution like your traditional bank or credit union. Most savings accounts are free to open, and most don’t require a minimum amount on the account. 

If they deposit into savings accounts in a bank insured by the Federal Deposit Insurance Corporation, depositors can rest assured they’ll get their money back if something goes wrong with the bank. FDIC insures as high as $250,000 per depositor per insured bank.

As stated earlier, you earn interest with your savings account, and these interest rates vary from one bank to another. They compound with time. Withdrawals are restricted in savings accounts to only a certain number per month, and exceeding this limit could incur extra withdrawals fees, account closure, or converting the account to a checking account.

Note that the interest you earn in your savings accounts is considered taxable income. 

Types of Savings Accounts

Various types of savings accounts exist for various purposes, according to the needs of the customer. Below are some of the common types.

Standard Savings Accounts

The standard, basic, or traditional savings account is the most common savings account. With it, you earn a lower annual percentage yield, and you can open one at your traditional bank or credit union.

Most times, these types of accounts come with a monthly maintenance fee and/or a minimum balance fee. For most of them, the monthly withdrawal limit is placed at six withdrawals per month by the Federal Reserve under the Federal Reserve Regulation D, a law that limits the number of transfers or withdrawals from savings accounts.

Online Savings Accounts

Online savings accounts are accounts that are opened with an online bank or digital financial institution that operates solely online. Here, instead of brick-and-mortar branches, you have mobile apps and websites that are completely resourceful, fully optimized, and easy to navigate to enable you to conduct your banking transactions with ease.

Online savings accounts enable you to carry out your banking activities or manage your accounts from the comfort of your smartphone. Given that they’re so convenient, it’s no surprise they’re gradually becoming the crowd’s favorite option. Of course, some people prefer the interaction with human beings that comes with traditional banks and wouldn’t mind having to go over to the bank to carry out every transaction, but most are gradually opting for a more convenient option.

Not only do the best online savings accounts offer higher interest rates than brick-and-mortar banks, but they also offer lower fees and are generally more affordable than most traditional banks while being regulated by the same regulatory bodies.

Different banks offer different ways of depositing and withdrawing money from online savings accounts, some of which may include wire transfers, linked debit cards, other linked accounts, or checks. Before choosing an online bank to open an online savings account with, make sure that the options on offer suit you.

Money Market Accounts

If you’re looking for a savings account that also allows you to have a payment card, checkbook, or debit card, then a money market account is probably your best bet. A money market account offers higher interest rates than standard savings accounts.

Money deposited into money market accounts is also insured by the FDIC and the National Credit Union Association, depending on the financial institution. For most people, the money market account offers the best of both worlds because they get to earn higher interests on their savings and also write checks or make purchases with a debit card, without having a linked account.

Money market accounts also have a regulated number of withdrawals monthly, but they give you more convenient access to your account.

Certificates of Deposit

These are a type of savings account where a larger sum of money is deposited into an account for a long period. The commitment period for CDs varies according to banks, but they could be as long as 10 years or as short as three months, depending on the terms of the bank and the interest rate attached.

It goes without saying that you get a higher interest rate for longer periods and higher deposits. The idea behind CDs is that you are not supposed to withdraw the deposited money until the agreed time elapses because making withdrawals before the agreed time may come with extra fees or charges, depending on the bank or financial institution. While some banks may offer no-fee early withdrawals, their rate may not be as high as others.

It’s advisable to deposit only the money you have no intention of using any time soon in CDs. That way, you’ll get to enjoy the benefits of CDs in full.

Read our reviews of some of excellent CD options available on the market

Specialized Savings Accounts 

These accounts are tailored for a particular goal, purpose, or even person. It could be a health savings account, kid’s savings account, Christmas saving account, etc.

The idea is that since the account is being opened for a specific reason, there won’t be a need for you to make frequent withdrawals until it’s time to use the money for the stated purpose. They are not as common as other savings accounts, and they often come with special restrictions.

High-Yield Savings Accounts

Just as the name implies, these types of savings accounts offer a higher APY to customers. There are many high-yield savings accounts out there, both from online or brick-and-mortar financial institutions, and they offer a wide range of interest rates. The FDIC and NCUA also insure these accounts, depending on the financial institution.

Savings Accounts vs. Fixed Deposits

Both savings accounts and FDs earn interests, but that’s as far as their similarities go. As for the differences, we’ll distinguish them below.

  • A savings account is an account you open to save a fraction of your income from time to time, which you can access when necessary; while an FD is one where you deposit a fixed amount of money for a specific period and can only access the money at the end of the stated period.
  • The interest rate for FDs is much higher than that of savings accounts.
  • With your savings account, you don’t need an enormous sum to open one, whereas an FD requires you to open an account with a larger amount of money.
  • In savings accounts, your rates are nominal and the same regardless of the amount you deposit, whereas the interest you gain in your FD account depends on the amount of money you deposit.
  • You can access your funds when you need to with a savings account, but an FD only gives you access to your money at the expiration of the fixed period.

Average Interest Rates for Savings Accounts

When it comes to the average rates of savings accounts, online savings accounts offer a higher rate than the traditional brick-and-mortar banks. According to a report published by the FDIC in November 2021, the average interest rate of savings accounts in traditional banks is 0.06%.

The average interest rates for online banks vary from bank to bank, if you are looking for the best options you can get a rundown of some notable online banks and the interest rate they offer for their savings accounts.

Pros and Cons of a Savings Account

As much as savings accounts may sound convenient, they do have their disadvantages as well. Let’s discuss the pros and cons in more detail.

Pros

  • A savings account allows you to keep money aside for a rainy day, separate from your daily expenses.
  • You earn interest with a savings account.
  • Your money is insured by the FDIC or NCUA.
  • You have easy access to your money in case of an emergency.
  • You can have multiple savings accounts for different goals.
  • It can be easily linked to your checking account for accessibility.

Cons

  • Other instruments, such as treasury bills, offer higher interest rates for long-term savings.
  • The easy accessibility to funds may tempt and prompt unnecessary withdrawals, unlike bonds, fixed deposits, and so on.
  • Monthly maintenance fees apply.

How To Open a Savings Account

Opening a savings account is quite easy, provided that you meet the requirements to open one.

Before opening a savings account, consider what you hope to achieve with it. This will give you direction on the type of account to go for.

Next, carefully go through a list of various banks and their APY. You’ll want to painstakingly read between the lines to ensure you’re not missing out on any hidden clauses, conditions, or charges.

You may need to consider how much you’re willing to save, as some traditional banks require you to have a certain minimum amount for opening a savings account. This is not the case with most online banks.

We strongly advise you to make sure that the bank you opt for, whether online or brick-and-mortar, is insured by the FDIC and/or other regulatory bodies.

Finally, decide whether you want a bank with physical branches or if you’d rather deal with an online bank. Either way, you’ll have to provide your name, Social Security number, address, phone number, and a photo ID.

Conclusion: Is a Savings Account Worth It?

Depending on your financial situation and aspirations, a savings account might be the best thing that can happen to your financial life. Having your hard-earned money stored safely and earning interest is a far better option than having it eaten up by inflation. Just ensure you perform your due diligence before opening one.

FAQ

Can I have multiple savings accounts?

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Yes, depending on what you need the accounts for, you can have more than one savings account for different purposes. For example, one could be for Christmas savings, and another could be for health or vacation savings.

What is an online savings account?

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Online savings accounts are accounts that are opened with an online bank or digital financial institution that operates solely online; this means that they don’t have any physical branches. They offer a more convenient way of carrying out banking transactions with ease, and they also frequently offer higher interest rates than brick-and-mortar banks.

How is a savings account most useful?

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Savings accounts are most useful to save for specific short-term goals. With them, you can easily access funds to fulfill certain goals, unlike FDs or bonds that require you to keep your money for a longer period.

Does an online savings account have a minimum balance?

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Most online savings accounts don’t have a minimum balance. However, a few may require you to have at least $1 in your account to keep your account open, while others may need you to put a certain amount in your account so you can enjoy higher APY rates.

Is my money safe in a savings account?

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Money deposited into your savings accounts is insured by the Federal Deposit Insurance Corporation or the National Credit Union Association, depending on the financial institution. This applies to most online banks as well.

How does a savings account work?

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A savings account allows you to put away money for specific short-term goals while earning taxable interest on it. Withdrawals are restricted, and only a certain number of withdrawals (typically six) are permitted per month. Exceeding this limit could incur extra withdrawals fees, account closure, or converting the account to a checking account.

About author

Albert Einstein is said to have identified compound interest as mankind’s greatest invention. That story’s probably apocryphal, but it conveys a deep truth about the power of fiscal policy to change the world along with our daily lives. Civilization became possible only when Sumerians of the Bronze Age invented money. Today, economic issues influence every aspect of daily life. My job at Fortunly is an opportunity to analyze government policies and banking practices, sharing the results of my research in articles that can help you make better, smarter decisions for yourself and your family.

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