- A savings account is an account with a depository institution that holds money not intended for everyday expenditures.
- Savings accounts held at Federal Deposit Insurance Corporation (FDIC) member banks are protected by FDIC insurance.
- You can use a savings account for an emergency fund or for accumulating money over time, and then be able to access it when you’re ready.
Savings accounts are bank or credit union accounts into which you deposit money for safekeeping.
They are one of the most basic financial tools, and like all tools, their effectiveness depends on how you use them.
This article explains some basics to help you use savings accounts safely and effectively, including:
- Savings account definition
- How savings accounts work
- Advantages of a savings account
- Disadvantages of a savings account
- Uses for a savings account
- How to open a savings account
This article also addresses some frequently asked questions about savings accounts.
Savings Account Definition
What is a savings account? Here’s a technical savings account definition: A savings account is an account with a depository institution that holds money not intended for everyday expenditures.
That’s a bit of a mouthful, so let’s break down a couple of key parts of that definition.
A depository institution is typically a bank or credit union. They are federally regulated and offer federally-insured accounts.
Not being intended for everyday expenditures means that unlike checking accounts, savings accounts are not intended to be used for frequent payments and purchases.
How Savings Accounts Work
A look at some key features explains how savings accounts work. Below are some of the most important features of savings accounts.
They are federally insured
Savings accounts held at Federal Deposit Insurance Corporation (FDIC) member banks are protected by FDIC insurance. Similarly, savings accounts at credit unions regulated by the National Credit Union Administration (NCUA) are covered by NCUA insurance.
Both of these federally-backed insurance programs protect up to $250,000 per depositor at any one institution. If a bank or credit union fails, these insurance programs make sure depositors get their money back, up to the coverage limit.
There are some financial products that look and act like bank or credit union savings accounts but are not federally insured. Also, not all products offered by banks and credit unions are insured. So, be sure to check the insurance status for any account you consider opening.
Deposits are immediately available but may be subject to transaction limits
You can withdraw your money from a savings account at any time without penalty. Unlike certificates of deposit (CDs) which lock up your money for a set period of time.
Traditionally, savings accounts were limited to six third-party transactions per month. That meant that you could withdraw your money whenever you wanted, but could only make up to six payments or other transactions to third parties in any given month.
In 2020, the Federal Reserve suspended the six-transaction limit. However, just because the Fed stopped limiting savings account transactions doesn’t mean banks or credit unions have to allow more than six. They may choose to keep limits in place because it costs money to change systems and because accounts with fewer transactions can be handled more efficiently. In some cases, that greater efficiency results in higher interest rates for customers.
Savings accounts pay a variable interest rate
Savings accounts pay interest, though at a relatively low rate.
This interest rate is variable, meaning it can change at any time. So, the interest rate advertised when you sign up may not be what the account is paying next month.
Interest rates vary a great deal among different banks and credit unions. Often, the biggest banks pay the lowest rates. Also, online accounts generally pay higher rates than traditional, branch-based ones.
So, now you know a little about how savings accounts work, it’s time to look at the pros and cons of these accounts.
Advantages of a Savings Account
The safety of having your money insured by the FDIC or NCUA is a big plus. So is the flexibility of having your money available on demand.
Being able to earn interest on your money is also a positive feature of savings accounts, though it’s a fairly small plus since these rates tend to be on the low side.
Disadvantages of a Savings Account
The low interest rate of savings accounts is a disadvantage compared to other savings vehicles and investments. For example, CDs and bonds generally pay higher interest rates, and stocks offer growth potential.
Also, having an interest rate that can change at any time can work against you if rates drop. In effect, the flexibility of savings accounts works both ways -- you can access your money whenever you want, but the bank or credit union can change the interest rate on it any time it wants.
Uses for a Savings Account
Given how savings accounts work and their pros and cons, the following are examples of how you can use a savings account.
This is a reserve of money you keep on hand to cover unexpected needs.
Having an emergency fund can save you from going into debt from a financial setback. The flexibility of a savings account is ideal for an emergency fund. It can keep your money safe and earning interest, but available immediately when you need it.
Building money for large purchases
Let’s say you’re saving money for a major appliance, or a down payment on a car or a house. If you’re putting money aside from week to week, it wouldn’t be practical to start a new CD with each new paycheck. Long-term investments are out of the question too, because you’ll need the money before too long.
Savings accounts are ideal for accumulating money over time, and then being able to access it when you’re ready.
Holding tank for investments
Just as you may have to save up money gradually for a big purchase, you may have to build up a certain amount of money before you have enough to invest.
Or, you may want to hold some money ready for when the right investment opportunity comes along.
Savings accounts work well as this kind of holding tank for investments. They allow you to build up money bit-by-bit, keeping it safe and ready to invest when the right time comes.
Direct deposit of pay
People often have their paychecks directly deposited into a checking account so the money is easily accessible for paying bills and other expenses. However, having your pay deposited into a savings account instead can be an effective budgeting technique.
Depositing your paycheck into a savings account and then transferring only a budgeted amount into your checking account can help you use only what you had planned to spend.
How to Open a Savings Account
Opening a savings account is fairly straightforward. You’ll have to fill out some paperwork and provide legal identification and enough money to open the account.
The most important part of opening a savings account happens before you start filling out paperwork. There are a lot of choices out there, and savings account terms vary a great deal. So, shop around before you choose.
Some key things to look for when choosing a savings account:
- How competitive the interest rate is
- Rate tiers -- some advertised rates only apply for specific deposit amounts, so make sure you’re comparing rates that would apply to the size of your deposit
- Fees -- avoid savings accounts with monthly fees because these can exceed the interest you earn
- Minimum account size – this may apply when you open the account and any time afterward
- Branch locations, if you plan to bank in person
- Online access and tools if you plan to bank digitally
Simply opening a second account at the same bank won’t allow you to exceed the $250,000 deposit limit. This limit applies to the total a customer has at any one bank. If you have more money than that, you may need to spread your deposits among different banks, keeping the maximum at any one bank at $250,000. However, if you have a joint account, the insurance limit is $250,000 for each owner of the account. Also, if you have an IRA, that’s considered a different depositor than your personal account, so it would count towards a separate $250,000 limit.
Money market accounts often have better interest rates than savings accounts, but not always. Generally, their rates are fairly similar, so you might consider both savings accounts and money market accounts when choosing where to put your money. But don’t confuse money market accounts, which are federally insured, with money market funds, which are not.
Since savings accounts usually pay more interest than checking accounts, try to keep as much as possible in the savings account, with just enough in checking to cover upcoming expenses. Some institutions allow you to keep nothing in checking and automatically transfer money from savings to cover checks and debit card transactions. Otherwise, you may want to keep a cushion in the checking account to avoid overdrafts, since overdraft fees are very expensive.
Also, some checking accounts waive their monthly fee if you keep a certain amount on deposit. If this fee exceeds what you could otherwise earn in interest on your savings account, it may pay to keep enough money in checking to qualify for the fee waiver.