How Savings Accounts Work

Put your money into a savings account instead of a mason jar!

How savings accounts work can be a mystery to those of you who, up until now, have only used checking accounts. Frequently, you come to wonder about savings accounts when there is excess cash in checking. Or you might have decided to start saving in a formal way. Also, you might have heard that linking your checking account to a savings one is one way of bypassing overdraft charges.

Essentially, a savings account is a safe place to “store” money you will probably not need right away. Up to $250,000 it is protected by the Federal Deposit Insurance Corporation (FDIC). For more than $250,000, some banks add DIF Insurance. The “perk” is that you receive interest on those funds. Each month that interest is “compounded,” that is, the bank pays interest on the interest. The interest rate depends on the particular bank. That is why you must shop around.

There can be significant differences between the rates paid by brick-and-mortar banks and online-only ones. That is because online-only or Internet banks are not saddled with the fixed cost of real estate and in-person tellers. Therefore, they can offer better rates on not only savings accounts by also other products ranging from money market accounts to CDs (Certificate of Deposit).

However, the tradeoff at all banks for the interest perk is that, by law, banks limit the number of monthly withdrawals or transfers. That means those funds are not as totally liquid as those in checking. The law exists because the bank lends out some of that money. To do that, the law requires it must maintain a certain capital reserve. Part of that reserve is maintained in the form of the funds in savings accounts.

Opening a savings account requires a certain minimum deposit. That varies from bank to bank. Again, this is a reason for shopping around. The brick-and-mortar bank might require a higher amount than the online-only bank. In addition, there could be a requirement of maintaining a certain minimum monthly balance. Going beneath that could incur a penalty. Such a fee could wipe out the gains from interest. That is a feature to review before selecting the bank to do business with.

In general, a savings account can function as a multi-purpose personal-finance tool. For example, yes, the savings and checking accounts can be linked to prevent overdraft fees. A pre-set amount also can be transferred monthly from checking to ensure it will not be laying in the checking account too easy to spend. Employees whose workplace direct deposits their check sometimes arrange this automatic transfer. It establishes the habit of regular saving. Another use of a savings account is it can enhance your financial profile when applying for loans.

If you are among the growing number of Americans determined to save more and spend less, learning how savings accounts work might be the perfect way to begin the journey.

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