A traditional savings account is a simple investment vehicle designed to provide a high degree of protection, relatively easy access to one's funds, and a modest amount of interest. It, along with a checking account, are the most common forms of bank accounts for consumers.
While a traditional savings account may be relatively simple, there are a significant number of differences between the banking institutions that offer them and the features of any individual account. This article explains those differences, and defines the related terminology, to ensure you can make an informed decision when choosing an account.
Local Branch vs an Online Savings Account
One of the most important decisions when considering where to open a savings account is the choice between a brick-and-mortar institution and an internet-only institution. The choice often comes down to personal preference and how one intends to use the bank or credit union's services. A local branch generally appeals to consumers looking for the superior service available with face-to-face interaction, while an internet-only bank generally appeals to consumers that prefer the superior convenience provided through an internet-only bank's online experience. A more detailed list of the various pros and cons of each option follows.
Pros of a Brick-and-Mortar Savings Account
Access to face-to-face bank tellers
Generally free access to the bank's ATM network
Access to the bank's branch services, such as foreign currency exchange and coin exchange
May still have access to an online portal depending on the bank or credit union
May still have access to mobile banking apps
Cons of a Brick-and-Mortar Savings Account
Branch services are only available during business hours
Online tools, when they exist, are often inferior to those of internet-only banks
Generally offer lower interest rates on deposits
Often charge higher fees
Pros of an Internet-Only Savings Account
Provides superior online account management tools
Generally provides superior mobile banking apps
Banking tools and services are generally offered 24/7
Generally offer higher interest rates on deposits
Often charge lower fees
Often offers ATM fee reimbursement, effectively creating the largest network of free ATMs
Cons of an Internet-Only Savings Account
Lack of face-to-face options for service
Lack of branch level services such as currency exchange
Concerns about privacy and account security
Types of Savings Accounts
In addition to the traditional savings account that is familiar to most consumers, there are several variations or completely different products that share the name "savings account". A discussion of those savings account variations and similarly named products follows.
High Interest Savings Accounts
High interest savings accounts, also called high yield savings accounts, have become increasingly common and popular. There is no true difference between a high yield savings account and a traditional savings account other than the interest rate paid on the deposit. While the interest rate can be many times higher than a traditional savings account, the rates offered are still low when compared to historic rates. As a result, the fees associated with an account can be as important as the interest rate offered. Learn more about the typical fees by reading our section on savings account fees below.
When looking for the highest possible interest rate, it is helpful to fully understand APR vs APY, and the effects of compounding. An explanation of those two topics follows.
APR vs APY
The terms APR (Annual Percentage Rate) and APY (Annual Percentage Yield) are generally seen accompanying loan and deposits products.
APR is computed as the periodic interest rate x the number of periods in a year, and is a term used for loan products. The stated APR for a loan also often includes the costs associated with servicing a loan.
APY is the total rate of interest paid on a loan or deposit over an entire year (365 days). It takes into account the compounding of interest over the year. This is the term one should see next to all rates promoted for savings related products, and it enables consumers to make an apples to apples comparison of the earnings between two products.
Compounding interest is a phrase that describes earning interest on previously earned interest, in addition to interest on the original deposit. If one is earning a 1% APY on a $1000 deposit, their interest after the first year would be $10, for a total of $1,010. If that person keeps the interest within the account, the next year they would earn another $10.10. The additional $0.10 is the interest paid on the interest earned during the former period.
Different savings products can compound in different ways. The most common is daily, but monthly and quarterly compounding are also common. Since APY is used for deposits products, and the rate already includes the effects of compounding, most consumers don't need to concern themselves with the specific compounding approaches of their accounts (although daily is generally preferable). Consumers can simply compare the APY directly between accounts.
Below are some tables showing the impact of annual compounding at two different rates, for a period of 10 years.
Compounding Interest on a $1,000 Deposit at a 1% APY
End of Year Balance
The impact of compounding at this rate produces an incremental $4.62, or 0.46%. This isn't a large incremental gain, but it is roughly equivalent to 5 months of additional yield on the initial deposit.
Compounding Interest on a $1,000 Deposit at a 5% APY
End of Year Balance
The impact of compounding at this rate produces an incremental $66.84, or 6.68%. This is roughly equivalent to 15 months of additional yield on the initial deposit. As the APY increases, the impact of compounding also increases.
Joint Savings Accounts
A joint account is a bank account with more than one account holder. Any of the account holders have access to the full funds of the account, not just the portion that they deposited. There are two types of joint accounts; convenience accounts and survivorship accounts. With a convenience account, if the original depositor of the funds becomes deceased, the account becomes a part of that depositor's probate assets. If the account is a survivorship account, the other account holder or holders take on ownership of the account.
Joint accounts are commonly created between couples, between parents and teenage children, and between adults and their aging parents. Opening a joint account comes with several pros and cons, some of which are listed below.
Pros of a Joint Savings Account
A central account to cover the shared expenses between a couple
The ability to monitor the spending habits of the joint account holder
Increasing the amount of FDIC coverage above the $250,000 limit for a personal savings account
Ensuring immediate access to funds in the event of one account holder's death
Cons of a Joint Savings Account
One account holder may overspend any agreed upon limits
Both partners are responsible for any fees associated with the account
The entire balance can be subject to the creditors and debtors of any single account holder
There is a lack of privacy between the account holders
Opening a joint account is not very different than opening an account for a single holder.
Children's Savings Accounts
Many banks and credit unions offer special joint accounts for children, with unique promotions or incentives. These kid's savings accounts are often meant as a way for parents and the banking institutions to teach children about banking and the benefits of saving and investing. Opening an account is as simple as most joint accounts, but it is important to ensure the child has a social security number. Once the account is created, the cosigning parent is often the only party that can make withdrawals.
There are a wide variety of promotions and incentives which can be offered on savings accounts for children. These can often be higher interest rates on the balances, or interest rate incentives for routine deposits. Another desirable feature is an account with no or low minimum balances and no or low account fees. For those who prefer a local branch rather than an online account, the traditional passbook savings accounts may even be available, depending on the banking institution.
Education Savings Accounts
Any savings account can be earmarked for educational purposes, but a traditional savings account misses out on the tax benefits of a Coverdell Education Savings Account (ESA). An ESA is an investment savings account which can be opened at many banks or credit unions. The money invested in the account is tax advantaged, and any growth from those investments is tax free for the student when used for qualifying educational expenses. The contributions to the ESA must be made prior to the student turning 18, and the funds must be used prior to the student turning 30. Students with special needs have no limits on the age when they may use the funds.
Funds contributed to an ESA can be invested in stocks, bonds, money market accounts, and other investments, much like an IRA. The account can be used to pay for qualifying educational expenses at either public or private schools. Those schools include elementary, secondary (middle and high schools) and higher education institutions (colleges, universities and trade schools).
In order to quality for an ESA, one must meet the modified adjusted gross income (MAGI) limits. For 2016, those limits are $110,000 if filing taxes individually, or $220,000 if filing jointly. The contribution limit is $2,000 per beneficiary, but those limits are reduced as the individual our couple making the investment approaches the MAGI limit. The reduction, called a phase-out, begins occurring at $95,000 a year for an individual, and is linear. If the investor earns halfway between $95,000 and $110,000, the contribution limit would be half way between $2,000 and $0 ($1,000). It is possible to gift the money to the beneficiary and have them open an ESA for themselves, but we recommend consulting a tax professional before considering such an action.
Health Savings Accounts
A health savings account (HSA) is specialized savings product for use in making qualified medical related payments. The contributions to an HSA are tax advantaged, and generally reduce one's income taxes. The funds within the health savings account can be invested in a similar manner as an IRA. To qualify for an HSA, one must be enrolled in a high-deductible health plan (HDHP) which is often considered a type of catastrophic health insurance.
HSA Contribution Limits for 2016
Type of Contribution
Catch-up (ages 55 and older)
These accounts are often confused with flexible spending accounts (FSAs). FSAs are not an investment, and generally the funds deposited in an FSA must be used in the plan year they are deposited or be forfeit. A new rule under the Affordable Care Act allows employers to allow $500 in FSA contributions to roll over from one plan year to another.
IRA Savings Accounts
An IRA savings account is a type of tax deferred retirement vehicle. The funds within the account can be invested in a variety of ways, including stocks, bonds, mutual funds, money market accounts, and others. Most banks and credit unions offer these types of accounts to their customers. There are two primary types of IRAs; traditional and Roth.
The traditional IRA's contributions are tax deductible, up to an annual limit. The investments within the IRA are tax deferred, and are only taxed when they are removed from the account upon retirement. The Roth IRA's contributions are not tax deductible, but the investment and earnings can be withdrawn tax free upon retirement.
Both types of IRAs have specific rules around contributions, and rules or penalties around early withdrawal before retirement age. It is important to know the details about the benefits, rules and potential penalties of each before investing.
Getting a Savings Account
Submitting an application for a savings account is a relatively simple process. The application can be made in person at a local branch, or often online or via the phone. There are a number of items that are typically required for the application, which one would want to have available when starting the process. Those are:
Social Security Number (SSN)
A way of funding the new account, such as cash or the account and routing numbers for another account that can be used for a wire transfer
Information from the joint account holder, when opening a joint account
Upon the approval of the account, a number of account documents should be provided. The bank or credit union will also likely require a signature form, to ensure they have a valid copy of the account holder's signature on file.
Reasons for Denial
While is seems counter-intuitive that a banking institution would turn down a new client depositing money in a savings account, it can happen. The most common reasons for an account to be declined are:
An error on the bank's end
Negative banking history
Bad or poor credit
Anytime an account is declined, the first recommended step would be to contact the bank for more clarity. If the bank made any sort of error, direct communication provides the best possibility for a positive outcome.
If direct communication is not successful, the denied applicant can request a report from ChexSystems, which is a consumer reporting agency used by banks to check the banking background of potential clients. A free copy of their report is available to consumers once every 12 months, thanks to the Federal Fair Credit Reporting Act.
Savings Account Features
ATM Cards and Access
An ATM card is a card provided by one's financial institution that enables the user to access their accounts via an automatic teller machine (ATM). They are used to access the account, obtain account information, make deposits, make withdrawals, et cetera. A debit card is an ATM card that can also be used for purchases.
Banks generally permit free access to their ATMs from their customers. When using another bank's ATMs, fees for each transaction are typical. As a result, the availability of a bank's ATMs is one consideration when choosing a bank with which to open an account. Online banks often offer reimbursement for ATM usage fees, up to a monthly limit, since they do not provide their own ATMs. Also, many merchants offer a cashback option during a purchase when using a debit card, giving the account holder the ability to make a purchase and an account withdrawal in one transaction and without ATM usage fees.
An overdraft occurs when the available funds in an account falls below zero. This can often happen due to excessive ATM or debit card usage, due to unanticipated bank fees, due to deposit delays, or due to a host of other reasons. Banks will often allow an overdraft, and charge fees to the account holder as a result of the overdraft.
Many banks offer overdraft protection. Overdraft protection allows the account holder to link two or more accounts, so that a lack of funds in one is covered by a balance transfer from another. This commonly involves a savings account being used to cover overdrafts from a checking account, but other options exist, including using a credit card's cash advance option. Overdraft protection may be offered at no cost to the user, may be offered for a monthly fee, or may be offered with a fee per transaction.
Online and Mobile Banking
Many traditional banking services are now available online and/or via mobile apps. This is particularly the case with online banks, which may have no physical branches. Besides the ability to monitor one's account and report on its' history, mobile deposits and online bill paying have become very common. Online bill pay enables an account owner to receive and pay bills online. Mobile deposits enable account owners the ability to deposit a check via their mobile device, by taking a photo of the front and back of the checks. Other features often include balance transfer and account administrative services.
A direct deposit is a deposit made directly into one's account by the paying party. The most common instances are businesses paying wages to employees, or paying bills to suppliers. Another common example is the payment of tax refunds from state or federal governments. In order to setup a direct deposit, the paying party generally requires the payee's bank routing and account numbers. Both are commonly found on a check, so a voided check is often requested by the payer. When the direct deposit is to an account other than a checking account, contacting the bank is recommended to get the account and routing numbers.
The main benefits of direct deposits are speed and ease of deposit, when compared to the main alternative of a paper check. Another benefit is that banks will often wave certain account fees when an account is setup to be the recipient of direct deposits.
FDIC Insurance (and NCUA)
The Federal Deposit Insurance Corporation (FDIC) provides insurance on the deposits made at its member banks. This insurance helps protect the individual making the deposit, and that protection helps protect the bank from "runs" by its depositors when questions of the institution's health arise. FDIC insurance comes at no direct cost to the investor, or to US citizens. The member banks fund the insurance corporation.
Qualifying deposits are protected up to a limit of $250,000. The qualifying deposits include those in savings accounts, money market accounts, certificates of deposit (CDs), checking accounts, and others. Deposits at different banks are separately insured, so deposit amounts above $250,000 can be split between multiple banks to provide insurance for the entire sum. There are also different types of accounts, such as IRA accounts, which can be separately covered above the $250,000 limit even when with the same bank.
Credit Unions are covered by the National Credit Union Administration (NCUA) rather than the FDIC. The NCUA operates an insurance fund named the National Credit Union Share Insurance Fund (NCUSIF) which insures qualifying deposit accounts up to $250,000.
Given the number of institutions participating in the FDIC and NCUA, it is highly recommended that any deposit made be made with a participating bank or credit union. Before opening an account, be sure to research the institution and confirm the insurance coverage offered.
Other Things to Consider in a Savings Account
Minimum Deposit and Balance
Most banks and credit unions will require a minimum deposit to open an account, and a minimum balance to be maintained within the account. The penalties for failing to meet the minimum balance can range from account closure, to lower interest rates, to additional fees. It is important to understand the implications of falling below the minimum balance for any banking institution of interest, when deciding whether to open an account.
Banks and credit unions may use different methods to check whether the balance has met its minimum requirements. Knowing these methods is just as important as knowing the minimum balance requirements. Some of the most common methods are:
Daily balance: does the balance fall below the minimum at the end of any day?
Statement balance: is the balance below the minimum at the end of a monthly statement cycle?
Combined balance between all accounts: does the balance of all a customer's accounts fall below the daily or statement minimum?
Average daily balance during a statement cycle: is the balance below the minimum for a given statement cycle?
Federal regulations limit the number of withdrawals from savings and money market accounts to 6 per month. This includes transactions such as bill payments, overdraft protection transfers, wire transfers and electronic funds transfers. ATM withdrawals and in-person withdrawals are not included in that limit, and there are no limits to deposits made into the account. The penalty for exceeding this limit ranges from a warning, to a fee, to an account being closed (normally after multiple warnings).
A typical work around is to open a checking account at the same institution, and to use it as the primary account for any frequent transactions.
A bank's fees are as important as its interest rates. Every bank is unique in the fees it charges, and the costs of those fees, so it is very important to review them before opening an account. Fortunately banks provide customers with ways to minimize of avoid many of these fees, typically by maintaining a specific balance in the account or accounts. Below is a list of some of the common fees associated with savings accounts:
Monthly service fees: a monthly fee for maintaining and servicing the account
Minimum balance fees: a fee for dropping an account balance below the minimum
Account closure fees: a fee for closing an account
ATM fees: a fee for using another bank's ATM (in addition to that bank's usage fee)
Bank teller fees: a fee for visiting a bank teller at a local branch
Transaction limit fees: a fee for exceeding the maximum number of monthly transactions
Overdraft fees: a fee for drawing the funds in an account below zero
Statement copy fees: a fee for mailed, paper copies of account statements
Savings Accounts vs Other Deposit Accounts
Savings Accounts vs Checking Accounts
Checking and savings accounts differ in fundamental ways. Checking accounts are intended for frequent use of the funds deposited, and are geared more towards services than earning interest. Savings accounts are intended for infrequent use of funds, and offer higher interest rates at the expense of some of the ease of access to funds. A brief comparison of the features for savings and checking accounts follows.
An account designed for infrequent use of funds, risk free, and paying modest interest on deposits
An account designed for frequent use of funds, paying little to no interest on deposits
Of all of the account type comparisons, money market accounts and savings accounts are the most similar. They are both account types that offer a high degree of liquidity, are interest bearing, and are protected under FDIC or NCUSIF insurance. Money market accounts tend to offer higher interest than savings accounts, although high yield online savings accounts bridge that gap. Money market accounts also provide limited check writing in many instances. Unfortunately money market accounts often require higher initial deposit amounts to open. A brief comparison of the features for savings and money market accounts follows.
Money Market Accounts
An account designed for infrequent use of funds, risk free, and paying modest interest on deposits
An account designed for infrequent use of funds, risk free, paying modest interest on deposits, and allowing limited check writing
Generally low, but higher than traditional savings accounts
Minimum Balance Requirements
Generally higher than savings accounts, but still relatively low
A savings account and certificate of deposit have significant differences. The main difference is liquidity and access to your funds. Savings accounts have relatively simple access via withdrawals, while CD funds are locked in until the end of the CD's term, when it reaches maturity. In exchange for the reduced access to funds, CDs earn a higher rate of interest. CDs also tend to pay higher interest rates for higher deposit levels. A brief comparison of the features for savings accounts and CDs follows.
Certificate of Deposit Accounts
An account designed for infrequent use of funds, risk free, and paying modest interest on deposits
An account designed for higher interest at no risk, with no access to funds until the end of the CD's term
Generally high when compared to savings and money market accounts
Fees focus on early withdrawal before the end of the CD's term
Minimum Balance Requirements
Generally higher, with higher interest rates for higher deposit amounts
Generally 6 non-ATM withdrawals per month
Generally no withdrawals until the CD reaches maturity
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