What Is a Savings Account and Why Do You Need One?

A savings account is a type of bank account that allows you to safely store your cash while earning interest. It's offered by banks and credit unions, which use your deposits to fund loans and other investment activities. In return, the bank pays you interest on your balance. Savings accounts are federally insured, making them a low-risk option for saving and growing your money.

If you want to know what a savings account is, read on for what to look for in a savings account and how to differentiate between different kinds of savings accounts.

Why do you need a savings account?

Savings accounts are essential for financial health and stability. They provide a safe place to store and grow your funds while offering easy access when needed. You can use a savings account to build an emergency fund, save for large purchases, or set aside money for future needs.

They’re not good for regular transactions, however, as many are limited to six withdrawals per month, though you can withdraw as much as you’d like with each withdrawal.

Savings accounts at banks in the United States are almost always insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor per institution. That means joint accounts get up to $500,000 in FDIC coverage.

Savings Account: Pros & Cons

Benefits of savings accounts

Savings accounts come with several notable benefits:

• Safety: Savings accounts at federally insured banks and credit unions are insured up to $250,000 per depositor, making them an extremely safe place to store money.
• Interest earnings: Unlike most checking accounts, savings accounts earn interest, enabling you to grow your money. With high yields, your money grows exponentially over time.
• Liquidity: Savings accounts offer easy access to your funds while keeping them separate from your day-to-day spending money. You can withdraw at any time during your bank’s business hours. Online banking lets you enter withdrawals on evenings or weekends for the next business day.
• Goal-setting: Savings accounts are perfect for allocating funds to financial goals, such as saving for a down payment on a house or building an emergency fund. Savings accounts are helpful for vacation funds, wedding funds, and anything else for which you may need the money in a relatively short time.

Disadvantages of savings accounts

While savings accounts have many benefits, there are a few potential downsides:

• Low interest rates: Traditional savings accounts typically offer relatively low interest rates compared to other investment options. Even with high-yield savings accounts, you may do better with an investment account in the long run.
• Access limitations: Some financial institutions may still limit certain types of withdrawals and transfers from savings accounts to a limited number per month. And you usually can’t write checks from these accounts.
• Minimum balance requirements: Some banks require you to maintain a minimum balance in your savings account to avoid fees or earn the highest advertised interest rate.

Different types of savings accounts

Savings accounts are not a one-size-fits-all offering. You may want multiple savings accounts or a combination of accounts for different goals and needs.

Traditional savings account

Traditional savings accounts are the most common. They offer modest interest rates and are an excellent option for people looking for low-risk savings with easy access to funds. Savvy banking customers often keep a savings account and checking account at the same bank, even if they have additional savings accounts elsewhere.

High-yield savings account (HYSA)

High-yield savings accounts offer higher interest rates than traditional ones, allowing you to grow your savings faster. These accounts are typically offered by online banks, which can afford to pay higher rates due to lower operating costs. When they don’t have to maintain expensive bank branches, they can pass on the savings to customers with better rates and lower fees.

Student savings account

With lower minimum balance and fee requirements than traditional savings accounts, student savings accounts are designed for kids and teens. But the added benefits don’t always last indefinitely. Many of these accounts come with time limits before converting to regular savings accounts. When that happens, minimum balance or activity requirements are imposed, or you’ll have to pay a monthly fee.

Money market savings account

Money market savings accounts are a type of savings account that often offers higher interest rates in return for higher minimum balance requirements. They may also come with additional features, such as writing checks or using a debit card. You can think of a money market savings account as a checking and savings account in one.

Note: Money market savings accounts are different from money market investment funds. Money market savings accounts are FDIC-insured bank accounts, while money market funds are investments that can lose value.

Certificate of deposit (CD)

A CD is a time deposit account that offers a higher interest rate if you agree to leave your money in the account for a set period, known as the term length. Early withdrawals usually incur a penalty, measured in a specific number of months of interest. CDs are great when interest rates are falling, as you can lock in current rates for a longer period. However, when rates rise, you could lock yourself into a lower rate when more favorable rates become available with regular savings accounts. In this case, it might be better to keep you savings in a high-yield savings account.

How savings accounts work

When you deposit money into a savings account, the bank or credit union pays you interest based on a specified rate, usually advertised as an annual percentage yield (APY). Whether interest is compounded daily, monthly, or on another schedule, APY allows you to compare savings account interest rates across banks and accounts.

Interest rates vary widely by financial institution and account type. For example, many brick-and-mortar banks offer a paltry 0.01% APY interest rate for a regular savings account, while high-yield savings accounts at online banks sometimes pay hundreds of times more. For large balances, that can add up to a significant difference.

Money in a savings account is extremely safe. In addition to the bank’s financial stability, FDIC coverage is one of the best guarantees that you’ll get your money back, even if the bank goes out of business. Savings accounts at credit unions are insured by the National Credit Union Administration (NCUA) with similar limits.

The biggest drawback of savings accounts used to be the limited number of withdrawals. According to Federal Reserve Regulation D, depositors were limited to six "convenient" withdrawals or transfers per month. If you went over this limit, the bank could charge a fee. If it happens regularly, you could have your account closed.

Regulation D was suspended in 2020, then ended. However, some banks and credit unions may still choose to limit withdrawals from savings accounts.

How to maximize earnings from a savings account

To maximize earnings from a savings account, look for one with the highest APY and lowest fees while meeting your other needs for banking features. The APY considers the interest rate and how often interest is compounded, giving you a more accurate idea of what you'll earn. If you make regular deposits to your savings account and avoid unnecessary withdrawals, your balance should grow over time.

Fees can take a big chunk of your earnings, particularly when using an account with low interest rates. If you pay a monthly maintenance fee of $10, you could spend more on fees than you earn, leading to a monthly loss.

It’s also a good idea to consider how your interest rate compares to inflation. Even if your balance grows with monthly interest payments, the value of your account could slowly decline when you compare it to economy-wide cost trends.

How to open a savings account

Opening a savings account is a simple process for adults legally living in the United States. You can typically open an account online or at a bank or credit union. You must provide personal information, such as your Social Security number and contact details. A copy of your photo ID is also commonly required. Depending on the bank, you may also have to make a certain minimum opening deposit.

With online banking, you can often open an account in less than 10 minutes if you have all your information readily available.

How much to keep in your savings account

The amount of money to keep in a savings account varies widely depending on your personal and household needs. With multiple accounts, you could have different savings goals in different accounts.

For emergency funds, common advice is to keep at least three to six months of living expenses in easily accessible savings. Self-employed individuals and those with less stable incomes may want to double that to at least six to 12 months.

When saving for a home down payment, you’ll likely want to target saving 20% of your future home’s value. Saving for a car, you might want to save enough to pay in cash or enough for a substantial down payment.

In other circumstances, deciding what makes sense is up to you. For those without a strong financial background, consulting with a trusted financial advisor could be helpful when deciding how to plan for your financial future.

Other types of savings financial products

Some other accounts may work like savings accounts but are technically not savings accounts. Here’s a glance at common savings products you may find useful.

Cash management account

Cash management accounts are hybrid accounts that combine features of checking and savings accounts. They're usually offered by non-bank financial institutions like brokerage firms. Instead of FDIC insurance, they could be protected by the Securities Investor Protection Corporation (SIPC), though some get FDIC coverage through partnerships with outside banks.

IRA and Roth IRA

Individual retirement accounts (IRAs) and Roth IRAs are retirement savings accounts. They come with tax advantages but also restrictions on when you can withdraw your funds. When you have a long time horizon to invest, you’re likely best off keeping your IRAs with a brokerage firm, allowing you to purchase ETFs or other investments.

Health savings accounts (HSAs)

An HSA is a highly tax-advantaged account designed to cover medical expenses. The best HSAs include a savings account feature and allow you to invest in stocks or mutual funds. You'll be subject to taxes and penalties if you withdraw for purposes other than allowed medical costs.

529 plans

529 plans are taxed-advantaged accounts that can be used to help pay for education, from kindergarten through graduate school. Qualified expenses include tuition, fees, room and board, and related costs. Withdrawals not used for qualified education costs are subject to federal and state taxes and penalties.

TIME Stamp: A savings account is useful for managing wealth

A savings account is a major part of a stable financial foundation. The tool is useful for managing and growing your wealth. While these accounts come in several forms, each with pros and cons, they all offer a safe place to store money while earning interest. They’re particularly useful for storing funds for shorter-term goals, where you want the money to be liquid. Understanding how savings accounts work and how to choose the right one for you is a crucial step toward achieving your financial goals.

Frequently asked questions (FAQs)

What savings account will earn you the most money?

A high-yield savings or money market account typically earns the most interest. However, they might come with certain requirements or limitations. It’s a good idea to shop around and review interest rates and fees when choosing a savings account to earn the best return.

How to calculate interest earned on a savings account?

You can calculate interest earned on a savings account using a common formula.

Interest = Principal x Rate x Time

The principal is the amount of money you have in your account at the start of a period, the rate is the annual interest rate, and the time is the number of years the money is deposited. Remember that interest rates can change at any time without notice unless your money is deposited in a CD.

What is a health savings account?

A health savings account (HSA) is a savings account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses. HSAs are only available to individuals enrolled in a high deductible health plan (HDHP).

How do you close a savings account?

Depending on the institution's policies, you can close a savings account by contacting your bank or credit union, either in person, by phone, or online. It’s best to withdraw or transfer your funds to a different account before closing.