Pros and Cons of Savings Accounts

Pros of Savings Accounts

Opening a savings account offers many benefits, including:

Easy Access to Funds

Some savings vehicles, like certificates of deposit (CDs), impose a penalty if you remove money before the account matures, but you can typically take money out of a savings account at any time. Many banks offer both savings and checking accounts and let you link the two. This makes it easy to automate savings deposits and move money into your checking account when you need to use your savings.

Ability to Earn Interest

Money in a savings account earns interest, helping your savings grow faster than if it were in your checking account. While annual percentage yields (APYs) on traditional savings accounts aren't very high, high-yield savings accounts often have much higher APYs—in some cases, up to 10 times higher.

Federally Insured

Choose an account with a bank insured by the Federal Deposit Insurance Corp. (FDIC) or a credit union insured by the National Credit Union Association (NCUA) and your savings is guaranteed up to $250,000 per account type, per account holder. Even if the bank fails, your savings are protected.

Require Little or No Money to Open

Unlike some savings and investment vehicles, many savings accounts can be funded with no initial deposit. Many online-only banks have no minimum deposit requirements; brick-and-mortar banks are more likely to request a deposit, but it's often as low as $25.

Cons of Savings Accounts

There are also a few potential downsides to savings accounts.

Interest Rates Can Vary

Interest rates for both traditional and high-yield savings accounts can vary along with the federal funds rate, the benchmark interest rate set by the Federal Reserve. If the federal funds rate drops, your APY may drop, too, affecting how fast your savings grow.

May Have Minimum Balance Requirements

You might need to keep a certain minimum balance in your bank account to avoid paying account maintenance fees. Some types of savings accounts base your APY on your account balance. If your budget makes it hard to meet minimum balance requirements, you could face fees that will eat into your savings.

May Charge Fees

Not all banks charge fees, but many do. If you're not careful, bank fees can eat into your savings, potentially canceling out any interest you earn. Savings accounts may charge fees for overdrafts on your account, wire transfers, using out-of-network ATMs or making more than a certain number of withdrawals per month. There may also be inactivity fees if you go a certain number of months without making any deposits or withdrawals.

Interest Is Taxable

You'll have to pay income tax on any interest your savings earn. The good news: There's no tax on your savings account balance—just on the interest. For example, having $3,000 in a high-yield savings account earning a 4% APY would mean paying taxes on $120 in interest.

How to Choose a Savings Account

To choose the best type of savings account, follow these steps:

1. Consider what features are most important to you. For example, if you'd prefer a fixed APY and don't mind giving up access to your money for a while, you may want to open a CD. If you're starting an emergency fund, perhaps you'd prefer a high-yield savings account that offers high APYs and convenient withdrawals. You can also open more than one savings account, using each for a different purpose.
2. Compare what different banks and credit unions offer. Be sure to take fees, minimum balance requirements, restrictions on withdrawals, ATM networks, FDIC or NCUA insurance and the bank's online and mobile apps into account.
3. Complete an application and open your account. You can usually do this online or in person; check the bank's website for details and to see what documentation you'll need. At a minimum, most banks require some form of government-issued photo identification and your Social Security number. Make any initial deposit required.

Alternatives to Savings Accounts

A traditional or high-yield savings account isn't the only place to put your savings. Depending on your goals, you may want to consider the following options.

• Certificates of deposit (CDs) are interest-earning deposit accounts at banks and credit unions. Interest on CDs is usually fixed and typically higher than APYs of traditional savings accounts. However, you must leave the money in the CD for a set period, usually three months to five years. Because CDs generally charge penalties for withdrawing funds before the term ends, they're usually best for long-term savings goals such as a home down payment.
• Money market accounts combine elements of a checking and savings account and typically earn higher APYs than traditional savings accounts. You can write checks on a money market account, which is convenient if you need the money fast in an emergency, and may be able to make debit transactions.
• Emergency savings accounts (ESAs) are sometimes offered as an employee benefit. These plans deposit after-tax money from your paycheck into an emergency fund, which can make saving simple. ESAs earn interest, and some employers even make matching contributions. If your ESA is linked to a retirement plan, withdrawals before age 59 ½ may incur taxes and penalties on account earnings.
• Cash management accounts, available from non-bank financial institutions such as brokerages, mingle features of checking accounts, savings accounts and brokerage accounts in one. These accounts usually boast higher interest rates than standard savings accounts, are typically FDIC-insured through partner banks and allow you to write checks and pay bills online.

The Bottom Line

Saving money regularly is a positive financial habit that can help you reach life goals and reduce your reliance on credit cards. To put your savings growth on the fast track, set up automatic transfers from your checking account. Some employers will also deposit part of your paycheck directly into your savings.

Maintaining good credit is another healthy financial habit. Make it a practice to check your credit report and credit score at least once a year so you can spot potential problems and take action if needed.