What Is a High-Yield Savings Account?
Today’s article addresses a question we here at Fortunly get asked very often: “What is a high-yield savings account, and how to best take advantage of it?”
Since the outbreak of COVID-19, Americans have been saving up more money than ever. After all, if you can’t spend your hard-earned cash on a fine dinner or drinks with friends, you might as well invest it somewhere, right? With that in mind, this article will break down how these types of bank accounts work and explain what their advantages and disadvantages are compared to standard checking and savings accounts. Let’s get started, shall we?
What Is a High-Yield Savings Account?
This is a special type of savings account that offers much higher interest rates than traditional savings accounts. Depending on the bank, you could earn interest up to 20 times faster than with the average interest on a savings account, currently sitting at just 0.07% nationwide. Where a traditional savings account would earn you $5 per year, you are looking at about $100 during the same period with a high-yield account.
The key term here is the annual percentage yield. Much like the annual percentage rate determines the total interest you need to settle on a loan, the APY refers to the total interest you’ll earn on your savings account during one year. The higher the number, the quicker you’ll make money with your bank account.
How Do High-Yield Savings Accounts Work?
At this point, you are probably wondering, “What is the secret here?” After all, how is a 20 to 25 times higher yield on your standard savings account even possible, and why would you ever choose to store your money in accounts that don’t offer the best savings rates possible? Well, there are some disadvantages associated with this type of account. We’ll talk more about them in our pros and cons section further in the text, but for now, let’s explain a key concept related to high-yield savings - compound interest.
With traditional interest, your principal balance (i.e., the sum that you deposit into the account) is the only thing affecting the accrued interest. In other words, your total interest earned will only increase by a preset percentage of the funds you yourself have invested, disregarding any additional money earned through previously acquired interest.
On the other hand, compound interest considers both your principal sum and the interest it has earned so far. Interest can be compounded in this way daily, weekly, monthly, or even yearly. The more frequently this process occurs, the higher your overall earnings will be.
Are High-Yield Savings Accounts Safe?
Here is another popular question from our readers. After all, who wants to invest their life savings in a potentially volatile account, especially in the current unpredictable pandemic-stricken economy? The good news is that high-yield accounts are protected through the same means as traditional savings accounts. If you get one through a credit union, it will be insured up to $250,000 through the National Credit Union Administration. Opting for a bank offers the same kind of insurance, except that the coverage now comes from the Federal Deposit Insurance Corporation instead.
Pros and Cons of a High-Yielding Savings Account
These are the key advantages of this type of account:
- These accounts earn more interest and grow interest at a much faster rate compared to traditional savings accounts.
- You are typically not required to place high initial deposits or meet minimum monthly deposit requirements.
- The best offers are usually by online banks, which often forfeit any monthly account maintenance fees. Also, opening an online savings account is much easier and faster than doing so at a brick-and-mortar bank office.
- The money on your account is more freely available than if you used a Certificate of Deposit, but it still offers similar interest gains.
- Your money is federally insured up to $250,000, just like standard savings accounts.
There are also several downsides:
- Typical high-interest savings account will most likely be an online-only account. While this can be handy in many ways, it also comes with several drawbacks: It may take a few days to transfer funds into your physical checking account, especially if multiple banks are involved.
- You may not get a physical debit card or have an ATM/brick-and-mortar branch to take money out from.
- The interest rate on your account might fluctuate while you have money invested into it, which can be especially problematic in times of significant inflation. In other words, you are getting your annual percentage yield either way, but it may not always be what the bank initially promised.
- While your funds on high-interest savings accounts are insured by FDIC or NCUA up to $250,000, it might be more complicated getting your money back if all the transactions related to your account were conducted online.
- The federal withdrawal limit restricts all online savings accounts (including high-yield ones) to six monthly transactions, after which you’ll have to pay fees for any subsequent activity on your account. This practice has been lifted for the duration of the COVID-19-induced crisis, but don’t expect it to be a lasting change once things start getting back to normal.
High-Interest Savings – What To Look Out For
So, you’ve decided to get a high-yield account but don’t know where to start. Here are some tips on what to pay attention to when making your choice.
The main reason for getting a high-yield account is accruing interest quickly. As such, you’ll want to look at the interest rate first. To be more precise, you’ll want to check the annual percentage yield or APY. While it rarely has a fixed value, you’ll want to avoid banks that offer “promotional periods” and similar gimmicks, as your actual rate may end up being much lower than it appeared once that promotional offer expires.
Minimum Deposit and Monthly Balance
To get the highest-yield savings account possible, you’ll have to meet several criteria. One of the most common ones is having to keep a certain balance on your account each month. Alternatively, banks may ask you to make an initial deposit. Either way, make sure you know exactly what is expected of you to open and maintain an account before applying for it.
Ongoing Costs and Fees
Aside from the minimum deposit and balance figures, consider the types of ongoing expenses your account may accrue during its lifetime. If you’re still wondering how to choose a high-yield savings account, don’t forget to read the fine print of your chosen bank’s T&C document. The key thing is determining whether the bank charges regular maintenance fees and what sort of other fees may be charged to your account.
The government has lifted the federally mandated limit of six transactions per month during the current pandemic, but such a measure probably won’t last forever. Be mindful of the bank’s policy on violating the number of allowed transfers per month and any other conditions (such as not having enough money in your account) which may incur additional fees.
Deposit and Withdrawal Methods
As mentioned earlier, banks that offer high-interest accounts often operate online only. This can become a problem when there is no ATM or brick-and-mortar branch available to withdraw your money. It’s not just about getting your cash out - the best savings accounts will have multiple options for depositing your funds as well. Look for banks that offer several ways to interact with your account, including mailing in or depositing checks at an ATM and mobile banking.
We’ve already mentioned the importance of compounding interest when trying to calculate interest on a savings account: This type of interest is calculated not only based on your principal deposited sum but also on the interest that the account has already accrued. As such, the highest interest accounts will always be the ones that compound funds regularly. Look for accounts that do so at least once a month, or better still, on a weekly or daily basis.
One advantage that traditional savings accounts have over high-yield ones is that they are typically offered by the same bank that handles your other finances. This means that switching between your savings and checking accounts is a quick and straightforward process. High-yield accounts are usually the specialty of online-only banks, making transferring money to your checking account more difficult. Check whether your chosen bank allows linking multiple accounts and how easy it is to link new accounts from other banks to your existing high-yield one.
Frequently Asked Questions
How does a high-yield savings account work?
In essence, it’s a savings account with very high interest rates compared to standard savings accounts. However, it usually comes with certain restrictions, such as limiting the number of monthly transactions you can perform before incurring fees. Check out our guide above for a more detailed explanation of how these types of accounts work and what you should consider before creating one.
What is the downside of a high-yield savings account?
These accounts often come with their limitations compared to standard savings accounts. In addition to not giving you full access to your account, they may have a flexible APY rate, which worsens as time goes by, giving you less compounding interest than initially advertised. This, combined with potential inflation, can mean that you’re losing more money than you are making in the long run.
Can you lose money in a high-yield savings account?
If you pick a reputable bank insured by the Federal Deposit Insurance Corporation, the chances of losing any money in a capital loss are effectively zero. That being said, there is some risk involved: You can still technically lose money with any interest-bearing saving account if your variable APY takes a downturn and the inflation rate gets higher than your effective interest rate.
Do you pay taxes on a high-yield savings account?
Yes. These accounts are subject to income tax like any other capital earnings. If your yearly interest earned amounts to more than $10, you’d get taxed according to your standard tax rate minus any applicable deductions. Note that you are only taxed on the interest accrued and not your contributions, thankfully.
Which savings account will earn you the most money?
Generally speaking, you’ll want a high-yield savings account, as they typically offer higher compounding interest than a regular saver account does. In theory, this guarantees the best return on your money, but it does come with some caveats to consider. Check out our “What Is a High-Yield Savings Account” guide above to find out more about the differences between these accounts and regular savings accounts.
For years, the clients I worked for were banks. That gave me an insider’s view of how banks and other institutions create financial products and services. Then I entered the world of journalism. Fortunly is the result of our fantastic team’s hard work. I use the knowledge I acquired as a bank copywriter to create valuable content that will help you make the best possible financial decisions.
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