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Commercial banks provide financial services for small and large businesses, including checking and savings accounts, loans, lines of credit, letters of credit, underwriting, and payment processing. These services enable businesses to operate in domestic and international markets. What’s more, financing from commercial banks enable businesses to grow and drive the domestic economy.

Commercial banks are focused on supporting business’ financial needs, but they may also offer services to individuals (this is usually called retail banking). Read on to learn more about what’s unique about commercial banking, including:

•   What is commercial banking?

•   How does commercial banking work?

•   What are commercial vs. investment banks?

•   What are commercial vs. retail banks?

•   What are the benefits of commercial banks?

What Is Commercial Banking: A Definition

Commercial banking is defined as a financial institution that is dedicated to serving businesses. This differs from retail banking, which provides personal banking services to individuals. Typically, a commercial bank offers businesses everything from deposit accounts, loans, and lines of credit to merchant services, payment processing, international trade services, and more. In these ways, a commercial bank can be a vital partner in helping a business succeed and grow.

While commercial banks offer a suite of services for medium and large businesses, small and new business owners can also take advantage of their offerings. Sometimes, people starting an enterprise use their personal accounts for banking. It is typically better to seek out commercial banking and open separate accounts for business vs. personal finances. This simplifies record keeping and the payment of taxes, and it also helps keep these two realms separate in case of any legal action.

How Commercial Banking Works

Commercial banks serve small- to large-sized businesses. You may be familiar with their names, as many of them also have retail banking divisions. Three examples of commercial banks in the United States are JPMorgan Chase & Co., Bank of America Corp., and Wells Fargo & Co. All are regulated by the United States Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC).

One very important function of commercial banks: providing financing to businesses. Before a commercial bank extends a loan to a business, it assesses the creditworthiness of the borrower by looking at its assets, profitability, and size.

In addition, commercial banks provide an array of services, supporting businesses with transfers from one account to another, lines of credit, lockbox services, payment processing, and foreign exchange services. Here, a closer look at what a commercial bank offers:

Deposit Accounts

Commercial bank deposit accounts function like retail bank checking and savings accounts. They enable businesses to pay suppliers and employees by holding cash and, in some cases, may earn interest on the balance.

There are three main types of deposit accounts: demand, fixed, and savings.

•   Account holders can use demand deposits or current account deposits for business transactions. They typically do not earn interest and are subject to service charges.

•   The bank holds fixed deposits for a specific term. Deposits likely earn interest, and the account holder can make withdrawals.

•   Savings deposits function as both fixed deposit and current accounts. Depositors can withdraw cash from these accounts, but the amount may be limited. Savings accounts earn interest but probably less than a fixed deposit.

Loans

Businesses need capital to thrive. Whether hiring staff, renting office or manufacturing space, or buying materials and supplies, operating a business and growing it takes cash. Commercial banks extend business loans vs. personal loans and charge interest on the loans. That’s one of the key income streams for banks, after all. The bank likely turns a profit on lending, and the business gets the funds it needs to launch their enterprise or to expand or buy real estate or new equipment.

Lines of Credit

Commercial banks usually provide businesses with lines of credit. A line of credit is short-term funding that can help a company manage its obligations while it waits for cash flow to improve. For example, a company may have to wait for receivables’ payment in order to meet this month’s payroll. A line of credit can help bridge that gap.

Letters of Credit

A business may need to request a letter of credit from a commercial bank to show their creditworthiness and to secure goods or services from an overseas trading partner. A letter of credit can serve as a guarantee from the issuing bank of payment for the goods once the letter’s requirements are met. The requirements might include the shipping date and the address the goods should be shipped to. In this way, a commercial bank can smooth international trade and help its clients’ business grow.

Lockbox Services

Lockboxes facilitate faster payments for businesses. Bank customers can send payments to a post office box near the bank, and the bank deposits the payments or funds to the customer’s account. This help expedite the receipt of deposits and subsequent payments from the client to its providers. It can be a very helpful cash flow tool for commercial enterprises.

Payment and Transaction Processing

Commercial banks typically facilitate the payments that businesses receive from their customers through electronic checks, paper checks, and credit card payments. Commercial banks may also provide services such as chargeback management fraud protection. All of these services can help keep a business humming along.

Foreign Exchange

Cross-border payments are complex because of exchange rates and the fact that each country has a different legal system. Commercial banks can provide foreign exchange services so that a company can do business overseas with a minimum of time and effort. This can really streamline operations for a business enterprise so they can focus their attention on other activities.

The Significance of Commercial Banks

Commercial banks play a vital role in the financial life of the U.S. They help support the country’s economy by providing capital and services to businesses. By providing loans, they likely allow businesses to increase production and potentially expand, which boosts the economy, lowers unemployment, and encourages consumer spending. In addition, commercial banks support cross-border trade and transactions (say, by issuing revolving letters of credit) so that businesses can operate in international markets.

Commercial Banking vs Investment Banking

When considering the definition of commercial banking, it can be helpful to compare and contrast it to other kinds of banking. You’ve learned above what commercial banking is all about. Investment banking, on the other hand, is a subset of banking that is focused on creating capital for companies, governments, and other organizations.

While some financial institutions may combine commercial and investment banking, thanks to the Gramm-Leach-Bliley Act of 1999, the two kinds of banking serve different markets. Here’s more detail of what investment banks do:

•   Underwriting

•   Overseeing mergers and acquisitions and initial public offerings (IPOs)

•   Facilitating reorganizations

•   Aiding in the sale of securities

•   Brokering trades for institutions and private investors

Commercial Banks vs Retail Banks

Another important distinction is how commercial banks differ from retail ones. Some banks will offer both sets of services, but here’s what retail banks likely offer in terms of personal banking services:

•   Savings and checking accounts (you can often open these bank accounts online)

•   Mortgages

•   Personal loans

•   Debit cards

•   Certificates of deposit (CDs)

There are also alternatives to traditional banking that can assist with personal finance transactions.

Examples of Commercial Banks

It can be helpful to have specific examples of commercial banks to better understand what they do and how they work. There are three types of commercial banks: public sector banks, private banks, and foreign banks.

•   A public sector bank is one where the government owns a major share. Public banks provide funding for projects that benefit the local public and community, which could include infrastructure projects or affordable housing. The Bank of North Dakota (BND) is the only active public bank in the United States.

•   Most of the banks in the United States are private banks run by individuals or limited partners. Examples are JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co.

•   A foreign bank is any bank headquartered in another country but doing business in the United States. Two examples are Barclays Bank PLC, headquartered in the United Kingdom, and Bank of Bahrain & Kuwait BSC.

Benefits of a Commercial Bank Account

There are several reasons a business should consider opening a commercial bank account.

•   Your clients are likely to feel more confident making payments for services rendered to a business rather than an individual. Simply put, it’s more professional and may be perceived as more trustworthy.

•   Having separate bank accounts for your business and personal transactions can simplify accounting and taxes (business expenses are more easily deducted).

•   If you face legal or financial challenges with your business activity, your personal liability can be limited and protected.

•   Your business can apply for business loans from a commercial bank and finance expansion or costly equipment purchases with favorable lending terms.

•   Business accounts are FDIC-insured in the event the bank fails.

Is My Bank a Commercial Bank?

If your bank provides services to businesses, such as checking accounts, financing, lines of credit, and international trade services, it is likely a commercial bank. A retail bank, on the other hand, will provide services to individuals (joint vs. separate accounts, debit cards, personal loans, and more) and could be a department within a commercial bank.

The Takeaway

Commercial banking differs from retail banking in terms of the clientele it serves. Retail banks provide checking and savings accounts, loans, and other services to individuals to manage their day-to-day finances. Commercial banks, however, help businesses launch, operate, and grow with services like deposit accounts, loans, lines of credit, payment services, and more. They are critical to keeping our economy humming along.

If you are hunting for personal banking services, check out what SoFi offers. Our online bank accounts can help your money grow faster. When you open our Checking and Savings with direct deposit, you’ll earn a competitive APY, pay no account fees, and have access to your paycheck up to two days early.

FAQ

What is the difference between commercial banking and retail banking?

Retail and commercial banking serve different clients. Retail banking provides checking and savings accounts, financing, lines of credit, credit cards, and other services to individuals. Commercial banking usually provides checking and savings accounts, financing, underwriting, letters of credit, lines of credit, and other functions to businesses.

Is my money safe in a commercial bank?

Your money is as safe in a commercial bank as it can be. It is protected from loss due to bank failure by federal insurance up to $250,000 for checking and savings accounts, trusts, and IRAs or certificates of deposit, and stock investments.

What role does a commercial bank play in the economy?

Commercial banks support the economy by providing capital and services to organizations. These, in turn, can stimulate the economy by doing business, growing, and employing more workers. Commercial banks also facilitate cross-border payments so that businesses can move into international markets.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Photo credit: iStock/Passakorn Prothien
SOBK0422040

We work hard for our money, so it’s a nice change of pace when our money works hard for us, which is what a tiered-rate savings account can do.

Putting cash into any kind of savings account can help money grow, not only by keeping it separate from where we do our spending but by earning interest. One option that can be pretty appealing is a tiered-rate savings account. The interest rate that a tiered-rate savings account earns usually grows as the amount of savings increases — which can make stashing away cash even more motivating.

Learn more here, including:

•   What is a tiered interest rate?

•   How do tiered-rate savings accounts work?

•   What are the pros and cons of tiered-rate savings accounts?

•   What are alternatives to tiered-rate savings accounts?

What Is a Tiered-Rate Savings Account?

A tiered-rate account is a savings account that has more than one potential interest rate that can be applied. Usually, the interest rate for a savings account doesn’t vary depending on the amount in the account, though it may change based on prevailing market conditions. (However, since the point of savings vs. checking accounts is to earn some interest, a fixed rate can be perfectly fine).

The way these tiered-rate accounts generally work is that as someone’s savings grow, so does their interest rate. Interest rates are offered on a tiered scale with the largest balances getting the highest interest rates. The interest rates offered by these accounts are known as tiered interest rates or escalating interest rates.

The point of this financial product is to encourage customers to save more money as they work towards earning the highest possible interest rate. It also helps keep account holders loyal to their current bank if they are wondering, “Do I need long-term savings?” With a tiered-rate account, the answer may be yes since customers are rewarding for their continued saving.

How Do Tiered-Rate Savings Accounts Work?

Here’s a closer look at how a tiered interest rate and tiered interest-rate accounts work. As briefly noted above, with a tiered-rate account, the higher someone’s balance is, the higher their interest rate is likely to be. That means, as their balance grows, their interest rate has the potential to rise. This can make a person’s savings grow more quickly.

Tiered-rate accounts offer account holders different “tiered” interest rates that correspond with different account balances. For example, if Acme Bank offers a tiered-rate savings account they may give a 0.01% interest rate for savings account amounts ranging from $10,000 to $25,000. For savings ranging from $25,000 to $100,000 they may up that interest rate to 0.02%.

Tiered-rate savings accounts tend to have a minimum balance threshold in order to open an account for the first time. Typically, a minimum daily balance must also be maintained. These accounts may also require that their holders make a minimum amount of monthly transactions (which could involve deposits or transferring money to another account). This transaction minimum may exist to ensure that the bank earns enough from transaction fees to profit even when paying out a higher interest rate.

Characteristics of Tiered-Rate Accounts

The following characteristics are typically associated with tiered-rate accounts:

•   Interest rates rise as account balances grow

•   Minimum initial deposit and ongoing balance requirements

•   Minimum monthly transaction requirements

Pros of Tiered-Rate Savings Accounts

These are a few advantages typically associated with tiered-rate savings accounts.

Opportunity to Earn Higher Interest Rate on Savings

Tiered-rate savings accounts tend to offer higher interest rates than normal savings accounts do — especially for motivated savers who work to increase their account balances. (Incidentally, as you think about opening a new account, you may wonder whether opening a savings account affects your credit score. It typically does not; banks don’t usually pull a credit report in order to approve you.)

Potential for Money to Increase Quicker

Because interest rates can be higher with tiered-rate savings accounts, it’s possible for savings held in these accounts to grow faster than with other accounts (as long as the account holder doesn’t remove money from the account, that is). Thanks to compound interest, your money will make more money.

Recommended: How Does Compounding Interest Grow Your Money?

Cons of Tiered-Rate Savings Accounts

As to be expected, there are also some disadvantages associated with tiered-rate savings accounts that are worth keeping in mind.

Putting Money Elsewhere Can Be Better to Build Wealth

Yes, a tiered-rate account does offer the opportunity to earn interest on savings and to grow those savings. However, the interest rates offered by these types of accounts tend to deliver a lower return vs. other investments (such as investing in the stock market). While investing in stocks is riskier than earning interest in an insured savings account, consumers can potentially see much greater growth that way. This can be helpful when saving for long-term goals like retirement.

Need a Larger Account Balance for the Highest Rates

To secure the best interest rates through a tiered-rate savings account, consumers may need a very large sum of money held in their savings account. If someone doesn’t have that amount of money, they may find that a standard savings account actually performs better for them. They might also research which common bank account bonuses they could snag by opening one of these regular accounts.

Here at a glance is a chart comparing the pros and cons of tiered-rate accounts:

Alternatives to Tiered-Rate Savings Accounts

If someone is looking to earn money on their savings, there are a few different vehicles they can consider for earning interest on their funds.

•   High-yield savings accounts: High-yield savings accounts are similar to standard savings accounts, but they earn much higher interest rates. More often than not, high-yield savings accounts are found through online banks. These financial institutions can save big since they don’t have to finance bricks-and-mortar branch locations; they can pass along the savings to their customers in the form of higher interest rates, lower fees, and/or special bonuses.

•   Money market accounts: Money market accounts are typically insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA) like a savings account, so they are very secure. They tend to have a higher APY than a normal savings account. There is, however, a potential downside: Money markets may have significantly higher minimum deposit and balance requirements, and they can also have withdrawal limits much like some savings accounts do.

•   Certificate of deposit: Certificates of deposit vs. savings accounts can be a wise choice for some consumers. Also known as CDs, certificates of deposit are time or term deposits, meaning the money stays in the account for a specific period of time (typically six months to a few years, though longer and shorter products are available). If you withdraw the funds before what is known as the maturity date, or the end of the term, you will likely pay a penalty fee. Because of the commitment to keep your money on deposit for a set length of time, CDs may offer higher interest rates than savings accounts and money market accounts.

The Takeaway

If someone has a chunk of money available to set aside, they may find that a tiered-rate savings account can be a good option. It offers them a way to earn a higher rate as they sock away more cash. If, however, someone is just starting their savings journey, a standard savings account with a single interest rate may work more in their favor. In all situations, the aspiring account holder needs to balance such variables as interest rate, minimum deposit and balance requirements, and account fees. By evaluating those factors, the right savings vehicle should come into focus.

Want to earn more interest on your savings? Check out what SoFi offers with Checking and Savings. When you open an online bank account with direct deposit, SoFi offers a competitive APY right off the bat, charges no account fees, and gives you access to a network of 55,000+ fee-free ATMs, all of which can help your money grow. Another perk: SoFi recently announced that deposits may be insured up to $2 million through participation in the SoFi Insured Deposit Program¹.

FAQ

What is tiered APY?

Tiered-rate accounts offer account holders different “tiered” interest rates (which can be expressed as an APY, or annual percentage yield). The amount an account holder has on deposit will qualify them for a certain interest rate “tier” or level. Typically, the more money on deposit, the higher your rate.

What is tiering in banking?

Tiering in banking refers to tiered-savings accounts, which provide account holders with different interest rates based on their savings account’s balance. Usually, the higher someone’s account balance is, the higher their interest rate is.

Is a tiered interest rate good?

A tiered interest-rate structure tends to benefit savers who have high account balances since the more money you have on deposit, the higher your interest rate. If someone has a smaller amount of savings, a standard or high-yield savings account with a single interest rate may be more advantageous to them.

¹SoFi Bank is a member FDIC and does not provide more than $250,000 of FDIC insurance per legal category of account ownership, as described in the FDIC’s regulations. Any additional FDIC insurance is provided by banks in the SoFi Insured Deposit Program. Deposits may be insured up to $2M through participation in the program. See full terms at SoFi.com/banking/fdic/terms. See list of participating banks at SoFi.com/banking/fdic/receivingbanks.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOBK0522008

A term deposit, also known as a certificate of deposit (CD) or time deposit, is a low-risk, interest-bearing savings account. In most cases, term deposit holders place their funds into an account with a bank or financial institution and agree not to withdraw the funds until the maturity date (the end of the term). The funds can earn interest calculated based on the amount deposited and the term.

This guide explains what a term deposit is in more detail, including:

•   How term deposits work

•   What a time deposit is

•   Different types of term deposits

•   How to open and close a term deposit

•   The pros and cons of terms deposits.

What Is a Term Deposit or Time Deposit?

Time deposit, term deposit, or certificate of deposit (CD) are all words that refer to a particular kind of deposit account. It’s an amount of money paid into a savings account with a bank or other financial institution. The principal can earn interest over a period that can vary from a month to years. There is usually a minimum amount for the deposit, and the earned interest and principal are paid when the term ends.

One factor to consider is that the account holder usually agrees not to withdraw the funds before the term is over. However, if they do, the bank will likely charge a penalty. Yes, that’s a downside, but consider the overall picture: Term deposits typically offer higher interest rates than other savings accounts where the account holder can withdraw money at any time without penalties.

Compared to stocks and other alternative investments, term deposits are considered low-risk (they’re typically insured by the FDIC or NCUA), and the returns are correspondingly conservative.

How Does a Bank Use Term Deposits?

Banks and financial institutions can make money through financing. For example, they likely earn a profit by issuing home, car, and personal loans and charging interest on those financial products. Thus, banks are often in need of capital to fund the loans. Term deposits can provide locked-in capital for lending institutions.

Here’s how many bank accounts work: When a customer places funds in a term deposit, it’s similar to a loan to the bank. The bank will hold the funds for a set time and can use them to invest elsewhere to make a return. Let’s say the bank gives the initial depositor a return of 2% for the use of funds in a term deposit. The bank can then use the money on deposit for a loan to a customer, charging a 6% interest rate for a net margin of 4%. Term deposits can help keep their financial operation running.

Banks want to maximize their net interest margin (net return) by offering lower interest for term deposits and charging high interest rates for loans. However, borrowers may choose a lender with the lowest interest rate, while CD account holders probably seek the highest rate of return. This dynamic keeps banks competitive.

Recommended: Breaking Down the Different Types of Bank Accounts

How Interest Rates Affect Term Deposits

Term deposits and saving accounts in general tend to be popular when interest rates are high. That’s because account holders can earn a high return just by stashing their money with a financial institution. When market interest rates are low, though, people are more inclined to borrow money and spend on items like homes and cars. They may know they’ll pay less interest on loans, keeping their monthly costs in check. This can stimulate the economy.

When interest rates are low (as checking account interest rates typically are), the demand for term deposits usually decreases because there are alternative investments that pay a higher return. For example, stocks, real estate, precious metals, or cryptocurrency might seem more appealing, although these are also higher risk.

The interest rate paid on a term deposit usually depends on the amount deposited and the time until maturity. So, a CD of $10,000 with a maturity date of six months might pay 0.05% annual percentage yield (APY), while a certificate of deposit of $10,000 with a maturity date of five years might pay 0.15% APY. Also, if you have a larger deposit with which to open a CD, you will likely have more options; these may include higher APY earning.

Types of Term Deposits

There are two main types of term deposits: fixed deposits and recurring deposits. Here’s a closer look.

Fixed Deposits

Fixed deposits are a one-time deposit into a savings account. The funds cannot be accessed until the maturity date, and interest is paid only on maturity.

Recurring Deposits

With a recurring deposit, the account holder deposits a set amount in regular intervals until the maturity date. For example, the account holder might deposit $100 monthly for five months. Each deposit will earn less interest than the previous installment because the bank holds it for a shorter period.

In addition to these two types, you may see banks promoting different kinds of CDs, whether they vary by term length or by features (such as penalty-free, meaning you aren’t charged if you withdraw funds early).

Opening a Term Deposit

To open a term deposit account, search online for the best interest rates, keeping in mind how much you want to deposit, how often, and for how long. Most banks will ask you to fill in an online application. Make sure you read and agree to the terms of the agreement. For example, check the penalties that apply if you decide to withdraw your funds early as well as the minimum amount required to earn a certain interest rate.

Closing a Term Deposit

A term deposit may close for two reasons — either the account reaches maturity or the account holder decides to end the term early. Each bank or financial institution will have different policies regarding the penalties imposed for breaking a term deposit. Read the fine print or ask a bank representative for full details.

When time deposit accounts mature, some banks automatically renew them (you may hear this worded as “rolled over” into a new account) at the current interest rate. It would be your choice to let that move ahead or indicate to the bank that you prefer to withdraw your money.

If you want to close a term deposit before the maturity date, contact your bank, and find out what you need to do and the penalties. The penalty will depend on the amount saved, the interest rate, and the term. The fee may involve the loss of some or all of interest earned.

Term Deposits and Inflation

Term deposits may not keep up with inflation. That is, if you lock into an account and interest rates rise over time, your money won’t earn more. You will likely still earn the same amount promised when you funded the account. Also, once tax is deducted from the interest income, returns on a fixed deposit may fall below the rate of inflation. So, while term deposits are safe investments, the interest earned can wind up being negligible. You might investigate whether high-yield accounts or stocks, for instance, are a better option.

Term Deposit Pros

What are a term deposit’s advantages versus regular high yield bank account and other investments? Here are some important benefits:

•   Term deposit accounts are low-risk.

•   CDs or time deposits usually pay a fixed rate of return higher than regular savings accounts.

•   The funds in a CD or deposit account are typically FDIC-insured.

•   Opening several accounts with different maturity dates can allow the account holder to withdraw funds at intervals over time, accessing money without paying any penalties. This system is called laddering.

•   Minimum deposit amounts are often low.

Term Deposit Cons

There are a few important disadvantages of term deposit accounts to note, including:

•   Term deposits can offer lower returns than other, riskier investments.

•   Term deposits and CDs usually have fixed interest rates that do not keep up with inflation.

•   Account holders likely do not have access to funds for the length of the term.

•   Account holders will usually pay a penalty to access funds before the maturity date.

•   A term deposit could be locked in at a low interest rate at a time when interest rates are rising.

Examples of Bank Term Deposits

Here’s an example of how time deposits can shape up. Bank of America is the second-largest consumer bank in the United States, according to the Federal Reserve. As of May 2022, the bank offered a Standard Term CD account and a Featured CD account.

•   The Standard Term CD: A 12-month CD with a minimum deposit of $1,000 pays 0.03%.

•   The Featured CD: A 12-month Featured CD with a minimum deposit of $10,000 pays 0.05%.

As you see, the premium account, with a significantly higher minimum deposit, earns almost twice as much interest as the regular version. Still, neither earns what might be deemed a high rate.

Recommended: How Do You Calculate Interest on a Savings Account?

The Takeaway

Term deposits, time deposits, or CDs are conservative ways to save. Account holders place a minimum amount of money into a bank account for a set term at a fixed interest rate.

The principal and interest earned can be withdrawn at maturity or rolled over into another account. If funds are withdrawn early, however, a penalty will likely be assessed.

While these accounts typically have a low interest rate, they may earn more than standard bank accounts. What’s more, their low-risk status can help some people reach their financial goals.

If you’re looking for security plus a great interest rate, see what SoFi offers. When opened with direct deposit, our Checking and Savings pays a competitve APY. What’s more, we don’t charge any fees, so your money can grow faster.

FAQ

Can you lose money in a term deposit?

Most term deposits or CDs are FDIC-insured, which means your money is safe should the bank fail. However, if you withdraw funds early, you may have to pay a penalty. In a worst-case scenario, this could mean that you receive less money than you originally invested.

Are term deposits and fixed deposits the same?

There is usually no difference between a term deposit and a fixed deposit. They both describe low-risk, interest-bearing savings accounts with maturity dates.

Do you pay tax on term deposits?

With the exception of CDs put in an IRA, any earnings on term deposits or CDs are usually subject to federal and state income taxes. The percentage depends on your overall income and tax bracket. If penalties are paid due to early withdrawal of funds, these can probably be deducted from taxes if the CD or term deposit was purchased through a tax-advantaged individual retirement account (IRA) or 401(k).

Photo credit: iStock/Olga Trofimova

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOBK0422037

With the CD barbell strategy, you invest in short-term and long-term certificates of deposit, and don’t invest any of your money in medium-term CDs — a strategy that can help maximize income and minimize risk.

CDs have different terms, and generally the longer the term, the higher the interest rate. When you invest money in a longer-term CD, you can take advantage of their higher rates. The downside with a long-term CD is that your money is tied up for a longer period of time. You have more liquidity with a short-term CD, but you will typically earn a lower return.

By splitting your money between short-term and long-term CDs, the idea is to capture the best of both worlds. Here’s how a barbell CD strategy works, and whether it makes sense for you.

What Is a Certificate of Deposit (CD)?

A certificate of deposit, or CD is a time deposit account that offers a guaranteed return that’s typically higher than a savings or money market account.

With a CD, you invest a lump sum upfront (called the principal). The bank promises a specified interest rate that you’ll earn for a specific period of time (known as the term). Most CDs are insured against loss by the FDIC (Federal Deposit Insurance Corporation) or the NCUA (National Credit Union Association) for up to $250,000. Certificates of deposit are considered a type of cash equivalent.

CDs typically pay a higher rate than standard deposit accounts because the account holder agrees not to withdraw the funds until the CD matures. If you deposit $5,000 in a 5-year CD, you cannot withdraw the $5,000 (or the interest that you’ve earned) without incurring an early withdrawal penalty until the end of the five years.

If you do need access to your money before the end of the term, you might consider a certificate of deposit loan, where the bank gives you a loan with the money in the CD serving as collateral.

What Is the Certificate of Deposit (CD) Barbell Strategy?

The longer the term of the CD, the higher the interest rate you’ll earn, but the longer your money will be tied up. The CD barbell strategy is one way that you can attempt to get the benefits of both long- and short-term CDs. By dividing your money between long-term and short-term CDs, you will blend the higher interest rates from long-term CDs with the accessibility of short-term certificates of deposit.

In addition to the CD barbell strategy, there are a variety of different strategies for investing in CDs, including the bullet strategy and the CD ladder strategy. So if you’re wondering where to store short term savings, you have several different options to choose from.

Real Life Example of the CD Barbell Strategy

If you want to start investing in CDs and are interested in learning more about the CD barbell strategy, here is one example of how it could work. Say you have $10,000 that you want to invest using the CD barbell strategy.

•   You invest $5,000 in a 3-month CD earning 0.50%

•   You invest $5,000 in a 5-year CD earning 2.50%

Your total return would be 1.50% (the average of 0.5% and 2.5%). That’s less than you would get if you put all of your money in a long-term CD, but more than if you put it all in a short-term CD. Depending on your financial goals, you can adjust the terms of your CDs and the amount you put in each half of the barbell.

Typically with the CD barbell strategy, when your short-term CD expires, you’ll take the proceeds and reinvest it in a new short-term CD.

Benefits of the CD Barbell Strategy

Here are a few of the benefits of the CD barbell strategy:

Higher Returns Than Investing Only in Short-Term CDs

Because half of your money is invested in long-term CDs that pay a higher return, you’ll get a higher return than if you invested only in short-term CDs. This can make it a viable investment strategy if you need access to some of your money but also want higher returns.

More Liquidity Than Investing Only in Long-Term CDs

Another benefit of the CD barbell strategy is that you have easier access to your money than if you invested only in long-term CDs. Half of your money is in short-term CDs, which means that if you need access to your money after a couple of months, you can withdraw the money in your short-term CD when it matures without penalty.

Drawbacks of the CD Barbell Strategy

Here are a few of the drawbacks of the CD barbell strategy:

Excludes Medium-Term CDs

The barbell CD strategy focuses solely on short-term and long-term CDs, excluding medium-term CDs. Depending on your financial situation, you might find it worthwhile to include medium-term CDs as part of your investment strategy.

Ties Up Some of Your Money

When you invest in a long-term CD that won’t mature for several years, you won’t have penalty-free access to that money until the end of the CD’s term. While long-term CDs do usually come with higher returns than CDs with shorter terms, you need to make sure that you won’t have a need for that money until the CD matures.

Barbell CD Strategy vs CD Laddering

When Should I Use a Certificate of Deposit Strategy?

If you decide you need a long-term savings account, you might want to consider a certificate of deposit strategy like the CD barbell strategy.

CDs with different terms come with different interest rates, so there can be advantages to splitting up your money. Rather than putting all of your savings into one CD, you can distribute your money to a few different CDs as a way to diversify your risk and reward.

The Takeaway

CDs come with different lengths or terms, and the longer the term, usually the higher the interest rate that you’ll earn. A CD barbell might make sense if you want the benefit of having some of your money in a higher-interest CD, while keeping the rest of it more liquid (although at a lower rate) — hence the barbell analogy.

Using a CD strategy like the CD barbell strategy is one way to capture some of the higher returns with long-term CDs while still being able to access some of your money by using shorter-term CDs as well. You’ll also have your money tied up for a longer period of time, so there is a tradeoff that you’ll need to consider.

If you’re looking for better interest rates for your cash while maintaining easy access to your money, you might consider a SoFi high-yield bank account. Eligible account holders can earn a competitive APY if you sign up for direct deposit. Also, SoFi doesn’t charge account fees or management fees.

FAQ

Why is it called a barbell strategy?

The CD barbell strategy is so named because you are investing in CDs at either end of the spectrum of possible terms, with nothing in the middle. This is similar to the shape of a barbell that has weights on either end but nothing in the middle.

Does the CD barbell strategy make more money than CD laddering?

With CD laddering, you usually invest an equal amount of your money in CDs that mature each year. Which strategy makes more money will depend on exactly how you divide your money into different CD terms, as well as how interest rates change over the life of your CD strategy.

Does the CD barbell strategy make more money than the bullet CD strategy?

The bullet CD strategy is an investment strategy where you buy CDs that all mature at the same date. Which of these two CD strategies makes more money will depend on a couple of factors. The first is how interest rates change over time, and the second is exactly how you divide up your investments.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Photo credit: iStock/hachiware
SOBK0422060

A growth savings account is a savings account that earns a significantly higher rate of interest than a standard saving account. This enhanced interest rate means your money will grow faster, which sounds of course like a good thing.

But are these accounts always a good bet? Important points to consider are:

•   What is a growth savings account?

•   How do growth savings accounts work?

•   The pros and cons of a growth savings account

•   How to open a growth savings account.

What Is a Growth Savings Account?

So, what is a growth savings account? Growth savings accounts are similar to regular savings accounts, except they tend to earn more, even 20 times as much, interest than traditional savings accounts. Depositing money in a growth savings account (which may also be called a high-yield savings account) makes it easier to grow savings safely, while keeping those funds accessible.

You may get the best interest rate on a growth savings account at an online bank or credit union versus a traditional, or bricks-and-mortar, bank. However, even at their best, these savings accounts typically don’t have the very high growth of, say, a well-chosen stock portfolio, the kind that could have you living off investment interest.

How Do Growth Savings Accounts Work?

Growth savings accounts function in a similar manner to regular savings accounts. You open the account, put some funds in, and can continue to add to the money as you like, all the while earning interest. The difference is you’ll earn more interest, thanks to their higher rates. This may make it one of the more appealing places to put your cash, especially when saving for short- or medium-term goals, such as building up an emergency fund or taking a European vacation.

As you shop for a growth savings account, you’ll likely find a broad range of rates. Odds are a traditional bank will offer an interest rate well below 1.00% (perhaps 0.02%) at press time. An online bank with growth savings accounts may offer rates of 1.00% or more.

Worth noting: Any interest earned in a growth savings account or a regular savings account may need to be reported as taxable income.

Also, at some financial institutions, you may be limited to only six withdrawals or transfers a month, as is the case with standard savings accounts. For each following withdrawal, you could face a fee or even have your savings account closed or converted into a checking account. A number of banks have relaxed this rule; check with yours to see if they still cap the number of withdrawals per month.

Pros of a Growth Savings Account

Here are a few examples of advantages that come with opening a growth savings account.

Higher Interest Rates

Because growth savings accounts can offer higher interest rates, the money held in a growth savings account tends to grow faster than money held in traditional savings accounts that earn lower interest rates. When determining what is a good interest rate, also look into minimum balances. You may see that the more money you put on deposit, the higher the rate you earn can be.

Accessible Form of Growth

Keeping money in a savings account is a great way to earn interest. It also means your money stays very accessible, which wouldn’t be the case if you invested in the stock market or opened a certificate of deposit (CD), which should be left untouched for a specific term.

Good Way to Build an Emergency Fund

Because these funds are fairly accessible, a growth savings account is a great place to build an emergency fund. That way, the emergency fund can continue to grow until it might be needed.

Cons of a Growth Savings Account

There are also some downsides to growth savings accounts worth keeping in mind before opening one.

Limited Growth Opportunity

Yes, growth savings accounts do earn more interest than traditional savings accounts. However, when considering your long-term savings options, there may be more strategic investments that can enhance growth. If, for instance, you’re saving for retirement, which is a few decades away, you might take a look at the stock market for growth.

Withdrawal Limits

Growth savings accounts generally provide easier access to funds than keeping money in investments. That said, you may only be able to make six withdrawals or transfers per month, or else you risk running into fees or having your account closed or converted to a checking account. Check, though, with your bank about whether this six-transaction limit still holds true. Many financial institutions have abandoned this guideline over the last couple of years.

Earnings Are Taxable Income

The interest earned in a growth savings account can count as taxable income. Compare this to the growth that occurs in a Roth Individual Retirement Account (IRA). There, you won’t pay any income tax on investment earnings.

Recommended: What is a Roth IRA and How Does it Work?

Choosing a Growth Savings Account

When you’re looking for ways to earn more interest on your money, a growth savings account might be a good option. Shop around to find the best fit for your needs. Here are a few factors to keep in mind when looking for a new growth savings account:

•   Interest rates

•   Minimum balance requirements

•   Fees

•   Account features

•   Mobile app

•   Other product and service offerings

It’s important to note that a lot of growth savings accounts come from online banks that don’t have in-person banking locations. Keep that in mind if you prefer to manage your account in-person.

How to Open a Growth Savings Account

While each banking institution will have its own process, opening a growth savings account typically includes the following steps:

•   Fill out the application. When filling out a growth savings account application, you’ll usually provide details like your name, Social Security number, proof of address (say, from a utility bill), and government-issued photo ID.

•   Choose the account type. There may be different savings account types, such as an individual account or a joint account (to share with a spouse or family member). Select the kind that’s right for your needs.

•   Designate beneficiaries. It’s important to choose a beneficiary for your growth savings account, just as you might select a beneficiary for a 401(k) plan. This is the person who would receive the account’s funds if your were to become incapacitated or pass away.

•   Deposit funds. Some banks require a minimum initial deposit, so you may need to make that deposit to open the account.

•   Create login information. If the growth savings account is set up through an online bank, it will be necessary to create login information such as a username and password for the online account. Be sure to create a complex password with at least one capital letter, numbers, and symbols.

While there may be another step or two in some situations, that’s how to open a bank account.

The Takeaway

Everyone wants to earn more interest on their savings account. Growth savings accounts can do just that vs traditional savings accounts since they tend to have higher interest rates. These accounts can be a good way to increase the funds in your savings faster. They are not, however, for everyone nor for all situations. In some cases, investing can help earn more money on savings and help you achieve long-term financial goals.

If you are looking for a new growth savings account, see what SoFi offers. We’re dedicated to helping you bank smarter. Here’s a great example: When you open a new bank account online with direct deposit, you’ll earn a super competitive 4.60% APY and pay zero account fees. That means your money grows faster and won’t be eroded by miscellaneous charges. You’ll also get access to your paycheck two full days early.

If you are looking for a new growth savings account, see what SoFi offers. We’re dedicated to helping you bank smarter. Here’s a great example: When you open a new bank account online with direct deposit, you’ll earn a competitive APY and pay zero account fees. That means your money can grow faster and won’t be eroded by miscellaneous charges. You’ll also get access to your paycheck two full days early.

FAQ

How do growth savings accounts work?

Growth savings accounts function similarly to traditional savings accounts. The only difference between these account types is that growth savings accounts tend to have higher interest rates.

What does “growth account” mean?

A growth account — also known as a high-yield account — offers a higher interest rate than traditional savings accounts. This higher interest rate leads to more growth on deposited funds.

How much interest does a growth savings account earn?

Interest rates change all the time, so it’s hard to nail down an exact number on what to expect with a growth savings account. That being said, growth savings accounts typically offer an annual percentage yield (or APY) of 1.00%, and sometimes even more than 2.00%.

Photo credit: iStock/Eoneren

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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