What Is a Savings Account?

When you have money to save, you probably deposit it into your savings account.

But what is a savings account, and how does it work? What types of savings accounts might you want to consider? And what are the pros and cons of putting your money in a savings account versus other options, such as a brokerage account, 401(k) or IRA?

Below, we answer these and other commonly asked questions so you can feel confident with where you’re putting your money.

How does a savings account work?

A savings account is an interest-bearing bank account that offers you a safe place to store your money. They’re safer because they are FDIC-insured up to $250,000, so even in the event of a bank failure, your money is secure. This makes them ideal for emergency savings and other short-term goals.

When you deposit money into your savings account, the bank rewards you by paying interest, which can help your money grow over time. The interest rate is typically expressed in the form of an annual percentage yield (APY). Compound interest is calculated on both the money you put in and previously-accumulated interest. The higher the interest rate is, the higher the APY will be and greater your return will be.

Because most savings accounts do not come with checks or debit cards, to access the money, you will need to either visit a physical branch of your bank, transfer funds from your savings account to a checking account to withdraw from an ATM.

Types of savings accounts

In addition to the “traditional” savings account, there are other types, like those below, that may be better suited to different needs. (Each of these also earns interest and is FDIC-insured.) When deciding which account to use, think about what you’re saving for. A general savings account is often most flexible, but other account types may be better in certain situations.

High-yield savings account

A high-yield savings account offers a higher APY compared to traditional savings accounts. The highest yields tend to be offered by online-only banks, which do not have the same level of overhead and expenses as traditional brick-and-mortar banks.

The downsides? Some high-yield savings accounts require a high minimum account balance to open an account and qualify for the high yield. Online-only banks also do not have physical branches that you can visit if you have an issue that you would prefer to discuss in person.

Money market savings account

A money market account often has the features of a checking account, such as check writing and debit cards. These accounts often have higher interest rates than traditional checking accounts. This makes them ideal for individuals who want to earn interest on their savings while still being able to access their funds with ease.

Unfortunately, money market accounts may require a high minimum balance compared to other types of savings accounts. Dipping below this balance can result in fees.

Student savings account

Many banks offer a student savings account to high school and college students. These accounts typically offer features such as no account minimums and no monthly service fees, which make them ideal for students who tend to have less money.

As a note, these are not the same thing as 529 college savings plans, which are specifically designed to help parents save for their children’s educational expenses.

Certificate of deposit

A certificate of deposit (CD) can be thought of as a contract between you and your bank in which you agree to keep your money deposited for a certain length of time, and in exchange, you are guaranteed an interest rate typically higher than what is offered by traditional savings accounts. This makes CDs less liquid than a regular savings account because accessing your money prematurely typically results in fees, usually in the form of forfeited interest.

One strategy that allows you to reap the benefits of a CD without tying up your money is CD laddering.

CD laddering involves purchasing multiple CDs each with different term lengths or maturities. The goal of CD laddering is to grow your money while maintaining regular access to it.

Health Savings Account

A health savings account (HSA) may be an option if you‘re in a high-deductible health plan. With an HSA, you can save pre-tax dollars, lowering your taxable income. You can use the funds for qualified medical expenses.

The best part? Health savings accounts can grow over time, and any growth is tax-free as long as it’s used for your medical expenses.

When deciding on a plan, be mindful of the differences between an HSA and an FSA (flexible spending accounts). While both are tax-advantaged options to be used for qualified medical expenses, an FSA has a few more limitations. FSAs are only offered through an employer and funds must be used by the end of the year. HSAs can roll over from year to year (and you can take them with you if you leave your employer).

Pros and cons of savings accounts

Before you choose where to save your money, it’s important to understand the pros and cons of each option.

Benefits of a savings account

Savings accounts have a number of benefits, like:

• Your money is easily accessible: You can access the money in a savings account whenever you need it—unlike other options (like CDs) which lock your money away for a predetermined period. With a savings account, you can access your money easily by transferring between checking and savings account.

• You can (often) link your accounts: Most banks allow you to link your savings account to a checking account you hold at the same institution. This can make it easier to access your money in the event of an emergency or if you find your checking balance low.

• You earn more interest than in a checking account: Checking accounts typically offer little to no interest on the money you keep in them. Savings accounts come with the ability to make at least a little interest on the money you keep in them. Storing your money in a savings account may help you maintain your money’s value and combat inflation or help you lose less of its buying power.

• Your money is FDIC-insured: The FDIC insures up to $250,000 of the money in a savings account. (The same is true for checking accounts, money market accounts and CDs.) This means that you’re protected from losing your savings due to a bank failure.

Drawbacks of a savings account

There are also some drawbacks to savings accounts, including:

• Interest rates may not keep pace with inflation: While savings accounts do allow you to earn some interest, it’s unlikely that you will keep pace with inflation over time. That means that if you’re looking to grow or even just maintain the value of your money, you may want to look for other options.

• Accessing your money may cost you: Generally, most banks allow you to make a minimum number of withdrawals or transfers from your savings account each month. After that, you may be charged a fee.

• Transaction limits: Some banks, most often high-yield savings accounts, may put a cap on how many withdrawals you can make within a period (usually six within one month). If you exceed the maximum amount, the bank may charge you a fee, close your account or covert it to a checking account.

How much money should I keep in my savings account?

The answer to this question will be different for everyone. It really depends on your situation and entire financial picture.

That said, it’s typically a good idea to have at least some money set aside in a safe account that’s easily accessible. If you are building an emergency savings fund, most financial professionals will tell you to save about six months’ worth of expenses. This will be enough to cover most emergencies or see you through a moderate period of unemployment. If you’re an entrepreneur or work in a seasonal field, you may want to save up to 12 months’ worth of expenses.

If you are saving for a short-term goal, a savings account can be a good idea for those funds as well. But for longer-term goals, you can get a better risk-adjusted yield elsewhere.

Opening a savings account

While you can still open an account in person at a branch of your local bank, you can also now open most accounts online in minutes. That makes it even more important to shop around for the best interest rates and the lowest fees.

To open a savings account, you will need to provide the following:

• Name

• Address

• Contact information (email and phone number)

• Social Security number (SSN) or taxpayer identification number (TIN)

• Government-issued ID

Once you have fully stocked your emergency fund and covered any other short-term goals that you are saving for, you may want to consider putting any excess cash to work in other investment account. There are a variety of ways that you can invest your money, including low-risk investments if you are risk averse.

Your financial advisor can help you understand your options and show you how your savings account works in conjunction with your larger financial picture.

Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP^®, CERTIFIED FINANCIAL PLANNER^®, and CFP^® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.