How Do Savings Accounts Work?

By Emma Diehl · April 12, 2021 · 7 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

How Do Savings Accounts Work?

Peanut butter and jelly, chips and salsa, avocado and toast, and checking and savings? These things often travel in pairs, but they’re not one and the same.

Instead, a savings account serves to complement checking, and vise versa.

When you need a place to keep your money that you’ll use to pay bills or cover expenses, a checking account can be a good choice.

But when you want to set money aside for future needs and goals and earn interest on your money, a savings account can often be the better option.

Read on to learn about the different types of savings accounts and how they might come into play in a person’s overall financial plan.

What Makes a Savings Account Unique?

Savings accounts can be a great way to diversify a financial strategy. A person might not want to put all their money into a savings account, but a savings account can complement their larger financial plan.

Compared to investments, savings accounts can be a safer spot to put cash away for short-term savings. And, savings accounts typically earn more than checking accounts.

Savings accounts set themselves apart because:

•   They earn interest. Unlike many checking accounts, savings accounts are interest-bearing—that means the bank will pay a small annual percentage yield (APY), based on the money in the account.
•   They’re insured. The money in a savings account is insured by the FDIC (Federal Deposit Insurance Corporation). The FDIC was established in 1933 after the stock market crashed, and when an account is insured, it guarantees that the customer will be able to get their money even in the rare event that a bank goes out of business. Savings accounts in FDIC-insured institutions are generally a safe place to keep cash.

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Pros of a Savings Account

Savings accounts yield lots of benefits for their users. Account benefits vary by financial institution, so customers might want to check the fine print for rates and details.

Earned interest. As money sits in a bank account, it makes more money in interest. And as long as that money sits in the account, that interest will also earn interest. It might sound too good to be true, but your money provides a service to the bank. How it works: Customers open a savings account and deposit cash there to earn interest. The bank takes that cash and loans it out to other customers at a higher interest rate. But don’t worry, savings account holders can access their savings at any time.

Easy access. A savings accounts is typically more liquid than an investment account, making it a good candidate for short-term savings goals, since account owners can easily and quickly access their money. Typically, a customer can transfer the funds online with the click of a few buttons.

Low risk. Since savings accounts are liquid and easy to get to, they’re generally regarded as low risk. Savings accounts don’t have the risk associated with investing. If a person is saving up for a big purchase in the next year or two, they might want to consider keeping the money in a savings account, where they can access it easily without the concern of market volatility.

Cons of a Savings Account

While savings accounts have their fair share of benefits, they also have a few drawbacks. Depending on a person’s needs and savings goals, these accounts might not always be the best fit. Here are a few things to keep in mind while mulling over where to deposit extra cash:

They might require a minimum balance. Some savings accounts require a minimum balance, depending on the financial institution. That means the account can’t fall below a certain amount. If it does, there could be a fee or extra charges headed the account holder’s way.
Limited transactions. With the benefit of higher-than-average interest comes the drawback of potentially limited withdrawals, deposits, and transfers. The Federal Reserve lifted its rule that banks must penalize members who make more than six transactions per month from their savings accounts in 2020. However, banks can still penalize you (with fees) if they want to. It’s a good idea to ask your bank about its policy before making more than six transactions in a month.
Setup fees. Depending on the financial institution and type of account, there could be fees associated with opening a savings account. This varies by institution.

Types of Savings Accounts

While they follow the same general rules, not all savings accounts are built the same. These are the some commonly offered savings accounts:

Traditional savings. Consider this a beginner’s savings account. A traditional savings account is offered by most financial institutions, and typically comes tied directly to a checking account. A traditional savings account typically will have a low-interest rate compared to other savings accounts.

High-yield savings. As the name suggests, a high-yield savings account will have a higher yield than a traditional savings account. The higher APY may come with caveats that vary by bank, such as requiring a large initial deposit and/or monthly balance. The bank might also be more likely to limit transactions to six per month.

Online savings. Online-only banks don’t have to support expensive brick-and-mortar branches, which can enable them to offer annual APYs that are higher than traditional savings accounts. These accounts also tend to have low initial deposit requirements and typically don’t charge monthly maintenance fees.

Recommended: 5 Types of Savings You Should Consider Having

Alternatives to Savings Accounts

There are other short-term savings options that don’t involve investment risk. Here are a few alternatives:

Certificate of deposit (CD). A CD is similar to a high-yield savings account when it comes to interest rates. However, when a person sets up a CD, they have to commit to keeping it there for a certain amount of time, and early withdrawal can lead to penalties. As a general rule of thumb, the longer the length of the CD, the better the interest rate.

Money market deposit account (MMDA). MMDAs often come with high-yield savings, but account holders typically need to meet requirements and adhere to the transaction limits to see the benefits. These typically include a minimum balance, and a limited number of transactions per month (including deposits, withdrawals, and transfers).

Cash management account (CMA). A checking and savings account functions as both a spending and a savings account, and often offers a higher interest rate than a traditional savings account. With many CMAs, account holders can write checks, pay bills, transfer funds, and make deposits. CMAs are offered by both brick-and-mortar and online financial institutions.

How to Use a Savings Account

Generally, a savings account is used for short-term savings goals, like an upcoming vacation or large purchase. This type of account is generally used to save or plan for expenses that don’t come up on a daily basis.

If you have multiple short-term savings goals, you might choose to open multiple savings accounts. You don’t have to open up an account for every goal, but keeping separate savings accounts could make budgeting easier. Watching balances grow could be an excellent motivator to keep saving.

On the other hand, financial minimalists might be overwhelmed by juggling multiple account numbers and balances. In that case, having more than one savings account might cause more confusion than clarity. The important thing is knowing how much you are saving and where.

Some specific reasons a person might open a savings account (or two):

•   An emergency fund. Emergencies crop up when least expected. That means the money always needs to be liquid and available. A savings account can be a good place to build and keep an emergency fund.
•   Short-term saving goals. Many things could fall under this umbrella, including upcoming travel, saving for a downpayment on a home, or putting aside funds to purchase a car. A savings account can be a good place for savings goals you hope to accomplish within the next few months or a year.

These are just a few ways someone could use a savings account when it comes to personal finance. There’s no one right way to use a savings account, and depending on a person’s preference and goals, they might keep one or multiple savings accounts.

The Takeaway

A savings account is a bank account that lets you store your money securely typically while earning interest.

Using a savings account separates money you intend to use at a later date, say for a large purchase or upcoming event, from everyday spending money that is kept in your checking account.

High-yield savings accounts and online savings accounts often offer higher interest than traditional savings accounts.

SoFi Checking and Savings® is an online bank account that allows you to earn competitive interest, save, and spend–all in one account. And, you’ll pay zero account fees to do it.

Start saving with SoFi Checking and Savings today.

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