What Is A Savings Account?
A savings account is an interest-bearing bank account that provides you limited access to your funds.
Next to the checking account, savings accounts are one of the most popular products in banking.
They aren’t as complicated as other bank products like Certificates of Deposit or money market accounts, but there are some rules and best practices to follow with savings accounts.
Whether you’re opening your first savings account or you’re looking to move to something better, it helps to know the ins and outs of savings accounts so you can make the best choice possible.
Keep reading to learn all things savings accounts.
Savings Account Features
First, let’s talk about all the features (good and bad) of savings accounts.
FDIC Insurance
The FDIC insures a few types of bank accounts up to $250,000, savings accounts being one of these.
What this means is the government will compensate you up to $250,000 if something happens to your bank or your accounts.
For example, if you have $10,000 in a savings account at a bank that goes under tomorrow, the bank won’t have the funds to pay you. The government will step in and pay you your $10,000.
How could the bank not have the money?
Well, they don’t store your bills in a lockbox for you; instead, the bank just records in their system that you’re entitled to that deposit amount if you want it back. They pool your money with other customers’ funds and loan it to borrowers at interest.
Which brings us to our next feature…
Interest
As we previously said, banks are actually borrowing your money to make more money. They combine all their customers’ funds into a pool to loan to others at a certain interest rate.
To compensate you for lending them your cash, banks pay you interest on your savings.
This interest rate is lower than what the bank charges its own borrowers so the bank can make a profit on interest without leaving you empty-handed.
Most normal savings accounts don’t pay enough interest to keep up with inflation, though. There are special savings accounts called high-interest savings accounts with rates that at least match inflation, if not barely edge it out.
High-interest accounts are more common at online banks due to online banks not having to maintain a bunch of physical branches. If you are looking to grab an online bank without fees, check out Chime Bank.
It’s worth noting that some checking accounts also pay interest, but the interest rate is so low that it’s effectively a symbolic gesture.
Bonus/Promotional Incentives
Banks will often advertise high promotional interest rates to persuade you to open an account with them.
Your bank may also offer you a higher bonus interest rate if you meet certain criteria, such as avoiding withdrawals or making a certain amount of deposits.
When you’re looking at these types of offers, investigate their terms and conditions so you can be 100% sure you qualify for the bonus rate.
Neither of these should be prioritized highly when looking for a savings account, though; promotional interest rates and bonus incentives typically last for only a few months before reverting to the standard interest rate or being replaced by a new offer with different criteria.
Just think of these bonus rates as a nice little “extra” from your bank.
Minimum Deposits
Most banks require you to make a minimum deposit upon opening the account. Once the account is open, they then require you to maintain a minimum balance in the account.
Banks do this because there are costs associate with maintaining your individual savings account, among other overhead costs. Without any money in your account, banks have nothing to lend to others while they still have to keep your account open.
Many banks will waive the minimum balance requirement if you set up direct deposit with your savings account, as you’re guaranteeing a steady cash flow to your account.
Online banks tend to not have minimum balance requirements, so consider that in your savings account search. A few traditional banks have limited offerings without a minimum balance as well.
Withdrawal Limits
Banks are required to limit your savings transfers (out of your savings and into another account) and withdrawals to just 6 per month thanks to a Federal Reserve Board rule called Regulation D.
These withdrawal limits do 2 things.
First off, they serve a similar purposes to minimum balance requirements: they ensure banks have enough cash reserves on hand to pay out withdrawals and lend money.
But they also keep consumer interests in line with the purpose of savings accounts. In other words, they incentivize people to actually save money so they have cash to fall back on in case something happens.
Withdrawal limits are placed on the following types of transactions:
- Online transfers out your savings into any other account type
- Phone transfers
- Automatic transfers, such as auto bill pay
- Overdraft transfers
- Check/debit card transfers
There are a few transaction types that don’t contribute to your 6-withdrawal limit:
- In-person transactions at your bank
- ATM withdrawals/transfers
- Phone transfers if you mail your check to the depositor
Savings Account Fees
Savings accounts have a few fees you may have to contend with.
Maintenance/Minimum Balance Fees
Some banks charge a small maintenance fee to keep your account open. For example, Bank of America has a $5 monthly maintenance fee on its standard savings account. This fee covers costs for online/mobile banking, ATM use, fraud monitoring, and other features.
As you can see, maintenance fees are usually small, but any fee that doesn’t provide you something in return is something you want to avoid if at all possible.
Fortunately, banks do offer ways to avoid these maintenance fees.
Let’s go back to the Bank of America savings account. They waive this fee if you do one of the following:
- Keep $300 in the account
- Link your savings to a Bank of America Checking or Advantage account
- Enroll in their rewards program
Withdrawal Limit Fees
Although the government mandates banks to restrict you to 6 transfers or withdrawals per month from your savings, that doesn’t mean you can’t make a 7th or subsequent withdrawal.
You’ll just get hit with a fee. This is most likely to cover the bank’s lack of access to your cash if you withdraw it to often.
Bank of America charges $10 per withdrawal after you’ve hit 6 withdrawals in one statement cycle, so improper money management can add up fast.
Of course, there are ways around this fee too.
Bank of America waives the fee if you maintain a $20,000 balance or enroll in their rewards program.
Be careful, though: many banks will simply convert your savings account to a checking account if you abuse the withdrawal policy, as your savings account is essentially serving as a checking account at that point.
Paper Statement Fees
Banks are charging a few bucks per paper statement, most likely due to a mix of the banking’s increasingly digital nature and the inefficiency of snail mail, with a small dash of environmental awareness.
Oh, and there’s also a large chance of paper statements falling into the hands of those with ill intentions.
These fees are only around $2 or $3, but avoiding them is almost effortless. Just sign up for electronic statements only and you’re $2-$3 richer each month. If you want paper statements on file somewhere, just print them off.
Account Closure Fees
You have to be dead set on a certain savings account. Acting on any buyer’s remorse can result in you getting hit with an account closure fee.
Banks do this to dissuade you from jumping on promotional interest rates for a few months before ditching that account for another higher-interest account.
All you have to do to avoid this fee is keep your account open past its closure fee cutoff period.
In addition, your bank might waive this fee if you’re a loyal customer with multiple accounts and have spent several years banking with them. You’ll have to talk with them about that, though.
Why Open A Savings Account?
Savings accounts are excellent tools for several financial goals.
Emergency Fund
Emergency funds are key to weathering the worst financial misfortunes. Without them, you’ll be strapped for cash should tragedy befall you; you may be forced into crushing debt without extra cash stored somewhere safe.
Savings accounts work great as a vehicle for your emergency fund because they’re relatively accessible but with enough withdrawal restrictions to prevent you from recklessly spend it all.
And of course, you earn interest on your emergency fund.
Generally, you want at minimum 3 months of living expenses for the whole family saved in an emergency fund. However, 6 months gives you much more peace of mind without tying up too much cash in a savings account you won’t touch.
In addition, 6 months is generally safer if you have more dependents as there’s a higher chance some misfortune can occur.
What you do with the interest earnings on your emergency fund is up to you, though. You can keep use it to pad your emergency fund or transfer it somewhere else.
Sinking Fund
A sinking fund is simple a way to save money for a specific and typically large purchase.
For example, many open a separate savings account to save up for a down payment on a home.
Sometimes, they’re used for debt repayment as well. College students sometimes open savings account and build a sinking fund during their student years so they can have a head start on repayment after graduation.
Savings accounts are good tools to build sinking funds for the same reasons as emergency funds. It’s easier to save money when you’re at least slightly restricted from accessing your sinking fund, and the interest rate gives you a nice little boost.
High-interest savings accounts are even better as you’ll earn an appreciable (albeit small) amount of interest you can use on other things.
Budgeting Assistance
Tracking expenses is one of the first steps to creating a workable budget. It can be a bit difficult to do so, though.
Savings accounts make it easier because you can separate the money you spend from the money you save, allowing you to deduce your monthly expenses.
For example, if you take home $4,000 per month after taxes and you find yourself transferring around $1,000 to your savings every month, your monthly expenses are around $3,000 give or take a few bucks.
This budgeting tactic is especially useful for those with irregular income, such as entrepreneurs and the self-employed. Simply pay your expenses and throw any extra money into a savings account to gauge how well you’re managing your money. From there, you can work out how much extra income you need to earn or expenses you might have to cut.
As an added bonus, if you make a lot of money while self-employed and throw all the extra into savings, you’ll have some extra cash on hand to weather the “famine” part of the “feast and famine” cycle that comes with self-employment or entrepreneurship.
Don’t Rely Solely On Savings Accounts
Savings accounts are great for the specific scenarios we talked about in the previous section, but beyond that, you’ll experience diminishing returns.
See, many savings accounts fail to keep up with inflation. Some higher-interest accounts manage to beat inflation, but only by a fraction of a percent.
If you rely on savings account as your sole method of building wealth, you won’t get very far. Your may earn interest, but inflation will cancel your earnings out, stagnating your money’s growth.
Once you’ve saved up an emergency fund of 3-6 months, you should invest your money into higher-yield assets such as stocks. These investments beat inflation by a few percentage points so your money can truly grow. If you decide to invest in stocks, make sure to check out this article on how to get free shares.
The only times you should be touching your savings once your emergency fund is set is to:
- Draw on funds in an actual emergency
- Replenish emergency funds after an emergency
- Creating a sinking fund
Now that you’re armed with plenty of savings account knowledge, picking the one that’s right for you will be a lot easier. Good luck!
