How Savings Accounts Work

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If you have a few extra cash you don’t need right at this moment, then you probably should have a savings account. However, finding a bank or an equivalent financial institution to look after your money may be quite intimidating. With a lot of options available, it could also get confusing. Don’t worry, you’ve come to the right place! Learn how savings accounts workーwhere and how to get one and what’s in it for you.

Just the Nuggets

  • A savings account is a safe place where you keep and grow the money you don’t need now for future purposes.
  • A savings account is a money business for financial institutions and an accessible vault for savers. 
  • In exchange for placing your money in the hands of a financial institution, they give you an interestーa percentage of growth to your money the longer you save it. Usually, banks give the annual percentage yield (APY) or the actual money you’ll earn in a year assuming you leave your savings untouched.
  • APY rates for traditional banks are around 0.01%, 0.15 to 0.75% for credit unions, 0.25 to 0.43% for time deposits, and around 1% for online banks.
  • The Federal Deposit Insurance Commission (FDIC) will insure a certain amount depending on the account type. For a typical single savings account, FDIC will insure up to $250,000. For credit unions, the National Credit Union Administration (NCUA) provides the same amount.

Savings Account: A Sophisticated Piggy Bank

Perhaps you still remember in your younger years the thrill of your piggy bank getting heavier with every penny you insert into the coin slot. This is probably the first lesson parents teach their children about personal financeーlearning how to save. 

Further Reading:
Nurturing a Child’s Relationship with Money by Nick Maratta, MBA, CFP® (Your Mental Wealth Advisors)

When it comes to adults, the same discipline applies but just with a more sophisticated process. Instead of a piggy bank, you now have a savings account. It’s a safe place where you keep the money you don’t need now for future purposes. But unlike the piggy bank, the money you put inside a savings account grows with time. 

How Savings Accounts Work

Here’s how a win-win situation works between a financial institution and a saver.

There are several reasons why adults keep their money in a savings account. Keeping cash on hand is a constant beckon for unintentional expenses. Putting the money in an account instead is safer and fairly accessible for necessary spending. Not to mention, the longer you don’t touch the money, the more it grows with time through compounding interestーthe reward banks or financial institutions give you in exchange for placing your money under their care. 

Savings accounts are financial services offered by banks, cooperatives, and other financial institutions. These firms keep your savings and use them for money-lending services (i.e. loans with higher interest) or asset investments in other companies to grow your money even more. Essentially, it’s a money business for financial institutions and an accessible vault for savers. 

A Closer Look Into Compounding Interest

In compounding interest, you get the interest on top of another interest like a multiplying effect. Usually, banks give the annual percentage yield (APY) or the actual money you’ll earn in a year assuming you leave your savings untouched. The APY already takes into account both the simple and compounding interest.

Where r = annual interest rate and n = the number of times interest compounds per year

To understand it better, let’s look at an example. If you open a savings bank in Ally Bank, their APY is currently at 0.60%. If you put $100 as your capital into the account and leave it untouched for the whole year, the interest earned will be $0.6. 

That’s already a feat rather than keeping your cash cold in a safety vault or under the bed.

US Government Regulations on Insurance Coverage

The world has learned its lesson from the 1929 stock market crash, also dubbed as The Great Depression. At that point, people panicked all at once, and there was a mass withdrawal from the banks (bank runs). This has gotten out of hand that the banks weren’t able to keep up. 

To avoid this from happening again, President Roosevelt decided that the government should step in to regulate the banks. In 1933, the Federal Deposit Insurance Commission (FDIC) was born to secure bank depositors in the rare case of bank runs. So if you’re worried in the event that your chosen bank goes bankrupt, just be assured that FDIC will insure a certain amount depending on the account type. For a typical single savings account, FDIC will insure up to $250,000.

Credit unions, which will be discussed more later, have the National Credit Union Administration (NCUA) to provide insurance. Just like the FDIC, NCUA covers $250,000 for a single ownership account.

So if you want to keep your savings safe, you can put in a maximum of $250,000 in your account. Most importantly, make sure that the financial institution you got the savings account from is FDIC- or NCUA-insured.

Types of Savings Accounts

Any of the following types of savings accounts are secured through FDIC or NCUA insurance.

1. Traditional Savings Bank

Good old-fashioned banks handle piles of cash over the counter, in armored bank trucks, and even more inside top-security vaults. Examples of American traditional banks are Bank of America, Wells Fargo, Chase Bank, U.S. Bank, and PNC Bank. Savings accounts in these traditional banks have an APY of about 0.01%.  These banks have physical offices where you can open an account, apply for a loan, or deposit and withdraw some cash. They also have ATM stations spread across the region or country. 

As for the costs and restrictions, banks usually have a minimum maintaining balance. For any amount below the minimum balance, the bank will deduct charges from your account. Since savings are meant to be kept for a significant amount of time, withdrawals are limited to 6 times per month.

2. Credit Union Savings

Cooperatives create a credit union where their members share and enjoy the profit. It’s like a mix of a bank and a stock company—a bank because it offers savings accounts and loans, and a stock company because it returns the profits made from their products and services back to the members. Unlike traditional banks, interest rates in credit union savings accounts are higher while loans have lower interest rates without a need for a good credit score. 

Examples of credit unions in the US are State Employees’ Credit Union, Navy Federal Credit Unit, Space Coast Credit Union, Suncoast Credit Union, and Members 1st Federal Credit Union. Savings accounts in credit unions have an APY of around 0.15 to 0.75%. Since credit unions are nonprofit organizations, your savings are exempted from tax.

Most credit unions are exclusive, so you should research their requirements first and prepare a membership fee. Depending on the cooperative, ATMs may be fewer and mobile apps may be subpar compared to traditional and online banks.

3. Time Deposits

A certificate of deposit (CD) is a type of savings account where the money is locked up for a predetermined period in exchange for a higher interest rate. Traditional banks and credit unions offer CDs, so it’s best to ask these financial institutions about the rates and periods. The general rule is the longer the holding time and the greater the capital (such as in jumbo CDs), the higher the interest rate. The average APY for CDs could range from 0.25 to 0.43%.

1-Year CD Rate0.25%
5-Year CD Rate0.42%
1-Year Jumbo CD Rate0.28%
5-Year Jumbo CD Rate0.43%

This is ideal for savers who have plans for major purchases in the future such as houses, cars, wedding ceremonies, and more. When the CD matures, say after 5 years, the bank or credit union will let you know beforehand. You can choose to renew the certificate, reinvest it to CD ladders (investing in different CDs with staggered maturity dates), or withdraw it for spending.

4. Online Bank Savings

Savings accounts offered by online financial institutions are much more flexible because they don’t have fees for their physical branches. Most don’t need monthly maintenance fees, minimum balance, and even at times, minimum deposit. These high-yield savings accounts can have an APY of around 1%. Examples are American Express National Bank, Marcus by Goldman Sachs, and CIT Bank.

If you are looking for maximum interest rates and you find online transactions to be more convenient through user-friendly mobile apps, then an online savings account is the best choice for you. 

Pros of Savings Accounts

1. Safe and secure

Keeping cold cash at secret creases of your home is convenient but not secure. What if your house gets caught on fire or affected by calamities? You can’t afford to lose your emergency savings in times of emergency.

Banks have formidable security protocols over their clients’ wealth, so you can have peace of mind about it being in safe hands. Not to mention, your money in savings accounts is insured by the US government’s financial agenciesーFDIC & NCUA.

2. Money grows with time

Thanks to interest, you earn money just by letting your money sit unused in your account. No matter how small the interest earned is, that’s still a consolation compared to keeping it in your wallet.

Further Reading:
Rules for Growing Wealth by Kaleialoha K. Cadinha-Pua’a (Cadinha & Company)

3. Bills and ecommerce portal

Almost all traditional banks have an online savings account component. In just a few taps on your mobile phone, you can pay all your bills online through an app or an auto-debit arrangement to make sure you don’t lapse past your due dates. Although it’s a double-edged sword, you can shop online for emergency purchases by paying through online savings accounts especially during this COVID-19 pandemic.

4. Accessible enough

Emergency funds should be readily accessible in unprecedented times. Compared to money you’ve kept for investments in stocks or other similar assets, money in your savings account is liquid. It means you can access your funds and convert it to cash through a nearby ATM or branch for emergency spending.

5. Build good saving habits

Seeing a 5- or 6-digit figure in your balance is such a satisfying and proud sight for a diligent saver. It keeps you on track of your cash flow. More about good saving habits later.

Cons of Savings Accounts

1. Interest rate can’t beat inflation rate

According to the US Labor Department’s data, the annual inflation rates in the last 10 years range from 0.7 to 3 percent.

Compared with the APY rates mentioned earlier, interest rates for savings accounts won’t catch up to the inflation rate. But it’s better than not growing. When your emergency savings are set up completely, you can invest your extra money in stocks. If the market performance is stable, your investment money may catch up to the inflation rate.

2. Fees and maintaining balance requirements

When you create a savings account through a financial institution, you are technically hiring a fund manager. There are corresponding fees to this like initial deposits, minimum maintaining balance, overdraft (when you continue to withdraw money from your account with insufficient balance) fees, monthly fees, and excessive transaction fees. For example, the Bank of America has a $100 minimum maintaining balance, an $8 monthly fee, and a $10 fee when you exceed the 6-withdrawals limit.

You can get rid of these fees with online savings accounts. For example, Ally Bank has no such fees. 

3. Limited withdrawals

Savings are meant to be accumulated, not spent frequently. Savings banks follow the Federal Reserve rule of a maximum of 6 withdrawals per month. However, because of the COVID-19 pandemic situation, this rule has been suspended for the time being.

4. Accessible enough

Accessibility can both be an advantage and a disadvantage, depending on your preference. For some people, it may be harder to control their money especially when impulsive online shopping strikes.

5. Susceptible to phishing

Phishing is a cybercrime that involves scammers posing as trustworthy representatives of your banks or financial institution so they can gather personal information from you. They may send you a clickable link through a text or email. For extra protection, don’t engage in such suspicious activities, especially if they ask for your Social Security number and passwords.

How to Open a Savings Account 

1. Know what type of savings account is best for you

The overall features of each type of savings account have their pros and cons. Before opening an account, make sure to get the best one for your needs.

Traditional BankIf you need to deposit or withdraw cash more often, then ATMs and bank branches would be convenient for you. You can also avail of different bank services like loans, credit cards, insurance, and investments.
Credit UnionIf your workplace or local community has a credit union, it would be much better for you to get a savings account with them. Not only is it convenient in your place of residence, but you can also enjoy a lot of benefits (e.g. cheap loans and higher interest on savings).
Time DepositIf you’re preparing for a specific major purchase soon, time deposits will keep you from withdrawing your money before the maturity date. Interest rates are also higher than those offered by traditional banks.
Online SavingsIf you want to escape the fees in maintaining a bank savings account and you are at ease with online transactions, then the high-yield savings accounts are offered by online banks.

2. Contact the financial institution

Whether you choose a traditional bank, a credit union, or an online banking company, it’s best to contact them by phone or visit their website or office branch. 

For traditional banks, you can visit the closest branch to you and ask for the teller’s assistance in the account setup. For online banking, you can fill out an application form when you visit their website. For credit unions, it will depend on the cooperative’s systemーothers may have office branches and online registration.

3. Decide between individual and joint account

Get an individual account if you want a personal savings account. All transactions and personal information are between you and the financial institution you’ve trusted. Only you can access your account. 

However, if you choose to open an account with two or more people, get a joint account. This may be applicable for couples saving up for a home, for a parent and an offspring saving up for college, or just about any partnership control of the account. You can take advantage of the FDIC insurance of $250,000 per co-owner. Moreover, you can split the fees and the minimum deposit requirement.

4. Prepare the requirements

It’s best to ask the company for the specific requirements. In  general, they will ask for the following:

  • Basic personal information (e.g. date of birth, email address, contact number, etc.)
  • Social Security number
  • Recent proof of billing to show your recent address
  • Government ID

5. Fund your account

You can make an initial deposit to your account by handing cash or check over the counter or through wire transfer or online fund transfer. This is the last step before you submit your application. Wait for a few days for your account to be officially set up after the company has encoded your information into its system.

6. Set up your mobile app or online account

Lastly, sign up for your bank or credit union’s online account through their website portal or mobile app. Track and get easy access to your statements of account, balance, bill payments, and more.

Is it good to have multiple accounts?

More often than not, it’s a good strategy to set up multiple savings accounts for the following reasons:

  • You can max out the FDIC or NCUA insurance. Every owner is insured with $250,000 per account category (joint, individual, retirement, or trust account) and per financial institution. If you already have savings that’s more than $250,000, you can split it into different bank companies to make sure that all of your money is insured. 
  • If you think you should have an account in a traditional bank, a credit union, and an online bank, you can get one of each so you can enjoy all the perks.
  • As you enter a new chapter in your life, there are different financial goals to save up for. Aside from emergency funds, you also have to save up for your retirement, education, vacation, big occasions, upcoming business, homes, and cars. It’s confusing to keep all that money in one account. 

However, be aware that your account fees will also duplicate. Having less than five savings accounts is healthy and fairly manageable. 

5 Good Saving Habits

Aside from setting up a savings account, here are more tips to practice good saving habits.

1. Income minus savings = expenses

When your salary arrives, the most common scenario that happens is paying the bills first, next is for the basic needs, and what’s left goes to your savings. That’s not a reliable strategy to grow your savings. 

As Robert Kiyosaki has mentioned in his book Rich Dad, Poor Dad, make sure to pay yourself first. Whatever’s left of your salary should be adjusted accordingly for your expenses. This also keeps you in check to live below your means.

2. Follow the 70-20-10 rule

Divide your salary into different portions: 10% is for tithes, 20% is for your savings, and the 70% remaining is for your expenses. The percentage rule is flexible, but this is the general formula. As soon as you receive your income, set aside 20% of it and immediately transfer it to your savings account. The 10% allocation goes to the church or any charity you choose to give back to. Others use the 10% for retirement or debt payments, that works too. The remaining 70% is for your bills and other living expenses.

3. Track your cash flow

Install mobile budgeting apps so you can record every income stream and every expense that goes out of your wallet. Mobile apps are the most obvious strategy because you carry your cell phone everywhere with you. However, other options can be Excel spreadsheets or just plain old pen and paper. The important thing is to account for every penny you have and discover where you spend the most on. 

4. Know bad debt from good debt

Loans and credit cards have a bad stigma around them, but they boil down if you’re using them for accumulating assets. To put it simply, Robert Kiyosaki defines an asset to be something that brings money or value to your net worth. Otherwise, it’s a liability.

When you look at your credit card statement, assess if those items are a good investment or not. If those things would depreciate with time, then they’re most likely bad debt. Before or while building your savings, see to it that your bad debt is wiped out.

5. Spend on assets

Spending on a car loan for the sake of running a business is an asset because it brings more money into your net worth. But buying a car to get you from one place to another could be a liability. Similarly, buying a house to flip it is an asset. But buying a house without you living in it or without tenants is a liability. The bottom line is, spending is not bad as long as you do it to accumulate assets.

Closing Notes

Achieving financial freedom is everyone’s goal but it takes discipline and smart work. If your income increases and so does your cost of living, it does not make any difference.  As Robert Kiyosaki said, “It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for”. So don’t underestimate every penny you save. It holds so much potential when you let it grow with time.

Our References and Further Readings

Ally Financial Inc. (2018). How APY Works & What It Means For Your Savings. Retrieved on 2020-10-22.

Ally Financial Inc. (2020). Ally Bank Accounts and Rates. Retrieved on 2020-10-22. Editors. (2020). Stock Market Crash of 1929. Retrieved on 2020-10-22.

National Credit Union Administration. (2018). How Your Accounts Are Federally Insured. Retrieved on 2020-10-22.

Elizabeth Gravier. (2020). Here Are the 5 Best Brick-and-Mortar Savings Accounts of October 2020. Retrieved on 2020-10-22.

Marcie Geffner. (2020). Best Credit Unions – October 2020. Retrieved on 2020-10-23.

Andrew DePietro. (2020). 10 Savings Accounts With The Best Yield of 2020. Retrieved on 2020-10-23.

U.S. Inflation Calculator. (2020). Current US Inflation Rates: 2009-2020. Retrieved on 2020-10-23.

Matthew Goldberg. (2020). Federal Reserve lifts six-withdrawal limit on savings accounts. Retrieved on 2020-10-23.

Federal Trade Commission. (2019). How to Recognize and Avoid Phishing Scams. Retrieved on 2020-10-24.

Casey Bond. (2017). NCUA vs FDIC: Who Insured Credit Unions and Banks?. Retrieved on 2020-10-24.

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