Saving Accounts Full Guide – How Does it Works?

Last Updated: September 28, 2019
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A savings account is a basic bank deposit product that allows the customer to deposit money, keep it safe, and withdraw funds while the balance in the account earns a small interest. In this article, we explain how does savings account work, review their pros and cons, learn how to compare them and suggest some alternatives.

What is a Savings Account?

As we mentioned, a savings account is a basic bank deposit product that allows the customer to deposit money, keep it safe, and withdraw funds while the balance in the account earns a small interest.  The savings accounts that you will find in banks, credit unions, and other financial institutions have FDIC insurance coverage and usually pays interest on the deposits.

The interest rates have gone down over the years and it now pays less than 2 percent per annum as we approach the middle of 2019.  However, you can find a savings account that offers a higher interest rate than other accounts.

How Does it Work?

By their technical nature, savings accounts are akin to time deposits. Technically, the bank can require the depositor to notify the bank before withdrawing the funds or charge a penalty when the account holder withdraws the money before a specified date. While banks do not usually exercise this right, some institutions restrict the number of transactions that a depositor can make in and out of a savings account per month.  They also charge fees that depend on the average balance an account holder keeps in his account.  Banks do not provide checks for a savings account as a general practice.

It is relatively easy to transfer funds to and from a savings account but a depositor must observe the federal limits on the number and types of withdrawals he can make per statement cycle.  While deposits are without limits (you can make as many as you wish), the law restricts some types of telephone and electronic withdrawals (exclusive of ATM withdrawals) and transfers to only six per statement cycle.

In addition to the traditional savings account that we have described here, the United States and other countries allow some people to open special savings accounts for specific purposes.  Examples of these are Health Savings Account and Coverdell Education Savings Accounts.  Investors open these accounts to build funds they will use to pay for specific items, but these accounts have special rules and specific tax provisions to govern them.

Interest paid on Savings Account

What probably is its most obvious feature is that a savings account’s deposited funds accumulate to earn interest over time.  If you just keep your money under the mattress or in your wall safe, you could miss out on some earning potential – aside from the security risks you take.  In a savings account, you can earn interest on your money although the rate will depend on which bank or institution you open your account.  Online banks are offering higher rates because they have lower overhead costs than traditional brick-and-mortar banks.

Banks normally compound interest when they are computing for how much interest they will pay the depositor.  Compounding interest is basically paying interest on the interest. You earn from your initial deposit just like with simple interest and then you will continue to earn interest on the initial deposit together with the interest that you have already earned (as long as you don’t withdraw them).  In essence, the bank computes interest on your running balance so it’s constantly changing.  If you will let your money stay in your account, the interest will continue to compound, and your money will grow quicker.

When you compare it with certificates of deposit and other interest-bearing bank products, a savings account will earn a lower rate of interest.  You should shop for the best savings account terms and rates although the highest savings rate you may find would probably still be lower than that of other types of accounts.  So, if you’re willing to keep your money in the bank for a prolonged period – from a few months to a few years – you will earn more if you place them in a Certificate of Deposit.

How to Compare Saving Accounts

Comparing savings account rates is a good move but you can still go further.

You need to check other factors such as the minimum opening deposit, monthly maintaining balance, and accrued interest rate, to name some of them.  Nowadays, you can find a lot of banks that offer a free savings account with a low initial deposit requirement.

It’s good to try to have all the features you want in your savings account available such as mobile check deposit and account alerts.  Read the fine prints for any other provisions or requirements.  Find out the turn-around time if you want to transfer funds from your savings account to your checking account.  More importantly, look into the financial health of the banks you are considering.

Shop Around – Factors To Consider

Here are some other factors you should look into when you compare savings accounts.

How Much Do You Have

Most of the time, banks will not ask for a high minimum requirement, but some banks might require a minimum initial deposit.  The amount will vary per kind of account – you can put in as little as $10 or as high as $10,000.

 Deposits Schedule

For some accounts, you need to make regular deposits to earn a bonus – such as $1,000 every month.  If your plan is to set aside a fixed amount from your income every month, you would benefit from an incentive or bonus saver account.

Withdrawals

If you’re anticipating that you would regularly make withdrawals from your account, check if the bank will charge you a withdrawal fee.  Many savings accounts don’t facilitate BPAY and direct debit transactions.  The banks usually set these features to an everyday account.

Just remember that you can get a lot more from incentive or bonus saver accounts if you make minimal withdrawals.

Multiple Accounts

It’s common nowadays for people to maintain multiple accounts with different banks although you can still find some who stick to just one account.  If you’re opening an account and you need the flexibility of being able to link it with your other accounts, you should check whether your linked accounts should be with the same institution.

Savings Goals

You may be able to find some accounts that offer high introductory interest rates for a limited time.  If your savings goal fits within their promo period, they can be a great option for your money to earn more.

Branch or Online

Some accounts charge lower fees as long as you do your bank transactions online.  To some, this is a comfortable option – to do banking in the comfort of their living room.  But if you are traditional and prefer to walk into a branch or use your phone, you might not fully appreciate online banking.

How to Open a Saving Account

Opening a savings account normally takes just a couple of minutes whether you do it online, over the phone or in person.  You can also make regular deposits and withdrawals (but within federal limits) any time without having to think of any term length of the deposit or having to pay withdrawal penalties.

Online banking can provide the convenience of access to your funds 24/7 as long as you have an Internet connection.  It also allows you to link your savings accounts to other accounts, like your checking and money market accounts so you can transfer funds seamlessly.

Saving Account Pros

Growth.

Savings accounts let you earn interest on money that you leave in your account.  In effect, your bank will make small additions to your money, usually every month.  There are factors that determine how much interest rate the bank will pay such as the economic conditions and how aggressive your bank is in relation to other banks in the area.  The interest rate is generally quite low and may even pale in comparison to the inflation rate.  The upside is that your funds remain very safe since the banks insure them with the FDIC.

Liquidity.

Most banks and credit unions provide online access to your funds 24 hours a day, seven days a week.  Many institutions would also let you link your accounts together so that you can just transfer funds online and avoid paying withdrawal fees.  The cool thing is that you can move money from one account to another at your convenience, even outside of regular office hours.

Automatic Savings Plan.

This is a feature that automatically transfers a previously-specified amount from your paycheck into your savings account each time your employee pays you.  This is the application of the principle of “paying yourself first” and helps you develop a habit through force-saving.

Safety.

One main feature of a savings account is that it keeps your money in a safe place – inside the vault of your bank, credit union or a reserve bank.  If you keep your cash at home, thieves can steal them, fire can burn them down, or insects may damage them.  In a savings account, when the bank insures with FDIC, you avoid losing your money in case the bank or credit union fails to keep it safe or the business closes down.  Banks insure through FDIC while credit unions through NCUSIF.  People often call savings accounts at credit unions as share accounts.
Doesn’t require a huge initial deposit. You can open a savings account for as little as $25.  You can find some institutions that may even have a lower requirement where you can open an account with just $1.  This is good because it gives you a chance to begin saving your money, and you don’t need a big amount to start.

Joint Accounts

You have the choice to open a savings account with your partner so you both can save together in a single account.

Saving Account Cons

Low rates of return.

You can get a little bit more in a savings account compared to what you can get from a checking account, but it still won’t be as high a return you can get in other types of accounts.  As of July 2019, the average rate of savings accounts reached only around 1.8% per annum. Let’s say you have some idle funds that you won’t be needing for some time, you can usually put it in a certificate of deposit and earn a bit higher.  Or, if you want it to grow over the long term, you can invest in stocks, bonds, mutual funds, and ETFs because they can provide a higher rate of return.  Of course, you have to balance the risks that come with these instruments.

Withdrawal limits on a savings account.

Although technology has made it easy to transfer money from one account to another, you need to be mindful of the law.  The federal government has set a limit on the number and the types of withdrawals you can make per statement cycle.  Regulation D allows you a maximum of 6 transfers or withdrawals from each savings or money market account during a calendar month.

Fees and minimum balance requirements.

Some banks charge a monthly fee or have a minimum balance that you must maintain to avoid the monthly fee.  If you can’t keep your balance above the level that the bank requires, you may end up paying regularly to have your savings account open.  Often, the monthly fee that you will pay will be more than the interest you might earn from your money.

No tax savings.

The money that you put into a traditional savings account is often money that you’ve already paid income tax on.  Then, when you earn interest, the IRS will demand that you pay the full rate for them.  These features make them inferior to other investment choices such as IRAs, Keogh accounts and other vehicles that provide tax relief or deferment.

Insurance limits.

If your money in the bank is less than $5,000, you would probably ignore things like an insurance limit.  However, if you have a net worth of $250,000, you should be conscious of where you will save your cash.  Naturally, you want an option where they will have a 100% insurance cover.

Checking Vs Savings Account

In a checking account, you wouldn’t have to worry of how many checks you can issue each month, but in a savings account, there may be a limit to the number of withdrawals you can make either from an ATM or from a live teller.  There are also set limits on the number of transfers you can make from your savings account to your checking account.

Generally, your bank will not allow you to make payments directly from your savings account because of Regulation D, a federal law that limits certain withdrawals.

A checking account is more efficient when it comes to taking money out of your account because you can just write a check, withdraw from an ATM, use your debit card, or pay electronically.  So, if you need an account to service your disbursement needs, a checking account is more appropriate than a savings account.

Saving Account Alternatives

In case you prefer a different investment option, there are a couple of good alternatives to a savings account. In most of them, the expected yield will be a little bit higher – and also the risk.

Certificate of Deposit

By letting your money stay with them for a longer time, banks and credit unions will pay you a higher interest rate.  The usual terms are from one month to 60 months.  The institution will issue you a Certificate of Deposit (CD) as evidence of your deposit that will state the interest they are willing to pay – usually this is more than the savings account average rate of 1.80%.  Your CD has insurance under the Federal Deposit Insurance Corporation for up to $250,000.

Money Market Account

A money market account is basically the same thing as a traditional savings account – except that it has leveled up.  There are some additional limitations, primarily in the minimum balance that you need to maintain and a ceiling in the number of withdrawals that you can make each month.  The great thing about it is that the bank will pay you a higher interest rate if you meet these conditions.

Checking Account

If you can find a checking account that pays interest, you’d notice that the interest rate is even lower than that for a traditional savings account. However, if you shop around, you can find a few financial institutions that offer high yield checking accounts with a slightly attractive interest rate.

The catch is that you have to meet certain standards to earn a higher interest.  You’ll have to meet a higher minimum balance, make an only minimal number of transactions with the account, and linking the account to your personal payroll through direct deposits.  It’s a good option only if your existing saving and spending patterns jive with the criteria.

US Government Bond Funds

Putting your money in bonds and other debt securities is a conservative but sure-fire way to receive stable income on your investments.  U.S. Government Bonds are risk-free and safe because the U.S. government’s resources fully back these debts.  The only risk you have to contend with for these bonds is the interest rate fluctuation and the inflation gap.

Gold

If you compare gold with the other items in this list, you can conclude that this is not the safest alternative but when you look at the current market conditions around the world, this has earned its place here.

Even if historically, the price of gold has been unpredictable, it still could be an alternative to a savings account.  If you have good timing, you can make a killing in your return of investment.