Banking 101: Understanding the Different Types of Savings Accounts
Note: This article is part of our Basic Banking series, designed to provide new savers with the key skills to save smarter.
There are different types of savings accounts depending on how you want to leverage your money.
While checking accounts are typically for money that you’ll need access to regularly, savings accounts allow for fewer monthly transactions — often with higher interest rates. It’s important to know the difference between certificates of deposit, health savings accounts, individual retirement accounts (IRAs) and online savings accounts, to name a few.
Here’s how to tell different savings options apart and how to decide what works best for you.
Types of Savings Accounts
|Conventional savings account||Federal law mandates certain types of telephone and electronic withdrawals, including transfers from savings accounts up to 6 per statement cycle.|
|Online savings account||Higher APRs on average than from a conventional savings account|
|Certificate of deposit (CD)||Typically earn more interest on longer terms|
|Money market account||Could offer the ability to write checks or use a debit card|
|Health savings account||Funds for qualified health expenses|
|College savings account||Funds for qualified educational expenses|
|Individual retirement account||For retirement savings not employer-sponsored|
|401(k) retirement account||For employer-sponsored retirement savings|
Conventional savings account
Think of a conventional savings account as a traditional way to save money. Many banks or credit unions will offer this product with a low minimum account balance. Deposits at an FDIC-insured bank or NCUA-insured credit union are covered up to the legal limit.
The money in a conventional savings account will accrue interest, but not a lot. The Bank of America Advantage Savings account, for example, provides 0.03% APY. The average APY for a savings account at a brick-and-mortar bank is 0.28%, while the average APY at a credit union is 0.25%.
A traditional savings account is federally regulated via Regulation D which mandates certain types of telephone and electronic withdrawals, including transfers from savings accounts up to 6 per statement cycle.If you exceed that amount, you could be charged a fee, or your bank might cancel your savings account and convert it to a checking account. So, if you’re going to be taking money from your savings account more than once a week, you may want to consider one of the other types of savings accounts.
Online savings account
You don’t have to rely solely on traditional banking institutions to find financial products that are right for you. There are online savings accounts that work similarly to conventional savings accounts, with the major difference that you can’t visit the bank to talk to a teller.
With high-yield online savings accounts where you’re likely to get better technical support, you can find APYs higher than 2.00%. The average APY for an online savings account is 1.69%. This makes these accounts attractive to many savers who want the security of a traditional account with the benefit of earning more interest. You can compare savings accounts to find the best terms for you.
Certificates of deposit (CDs)
If you’re saving for a long-term goal and know you won’t need access to your funds soon, you could consider a certificate of deposit. It’s also good if you don’t want to risk investing your funds more aggressively in the market.
With a CD, which is insured up to the legal limit by the FDIC, you agree to a set amount of time that your money will be saved. That time period could be a matter of days or years (it’s generally from a few months to five years).
You need to be aware of CD penalties if you withdraw your money early. For example, Santander Bank charges three months’ interest if the CD is for a year or less. It charges six months’ interest if the CD is for more than a year but less than five years. You can find no-penalty CDs, but you’ll typically earn a lower interest rate.
You earn interest at a typically predetermined rate. Interest rates are usually higher for longer terms. For example, here are average APYs on certain CD terms:
- 3-month CD: 0.490%
- 6-month CD: 0.894%
- 1-year CD: 1.267%
- 18-month CD: 1.384%
- 2-year CD: 1.485%
- 3-year CD: 1.646%
- 4-year CD: 1.757%
- 5-year CD: 1.965%
With many CD accounts, your funds will be automatically reinvested if you don’t do anything during your grace period.
You need to pay attention to inflation. If your funds are locked in for a decade and inflation rises faster than your agreed-upon interest rate, your earnings might not go as far as you anticipated.
You should always shop around to compare CDs to find the best one for you.
Money market account
You can think of a money market account as a slightly more flexible traditional savings account, with the possibility of a higher interest rate (the average APY is 0.383%). This higher interest rate is typical because the money market account can invest in other financial products, such as a CD or securities, with the larger funds.
With a money market account, you may be able to write checks from the account. In some cases, you may even get a debit card linked to the account. Remember to watch out for monthly fees. Do the math to make sure the higher interest you would be earning offsets any potentially higher fees associated with the account.
You can compare money market accounts to check on that.
Health savings account (HSA)
If you can predict that you’re going to make at least some purchases related to your health in the coming year, you might consider saving money in an HSA. This functions like a personal savings account that you can only use for qualified medical expenses.
HSA contributions are made pretax, and any interest that your HSA savings earn is not taxed. However, you can only contribute to an HSA if you have a high-deductible health plan (HDHP). There are annual limits to the amount you can contribute. The limits for 2020 are $3,550 for individuals and $7,100 for families.
There are some HSAs that offer an APY of 2.00% or higher with a $15,000 deposit.
College savings account (529 plan)
A 529 plan can help you save for qualified educational expenses in the future by providing a tax-advantaged way to save.
There are two versions of a 529 plan:
- A prepaid tuition plan lets account holders buy credits at participating colleges or universities that can be used in the future. This plan is usually sponsored by an individual state.
- An educational savings plan is like an investment account opened for a beneficiary. The funds can be used for qualified educational expenses. This is state-sponsored as well, but some of the investments could be FDIC insured.
The IRS doesn’t specify an annual contribution limit for 529 plans, so most of the contribution limits are specific to your plan. However, federal regulations stipulate that the aggregated balance of your 529 plans cannot exceed the expected cost of the beneficiary’s higher education.
Even though a 529 plan is a popular way to save for college, it’s not the only way. You can actually use a CD to save money for school, whether you’re wanting to attend in a few months or saving for the future.
Retirement savings accounts
No matter where you save your money, you’ll also want to remember to keep setting aside funds for your retirement. There are a number of ways you can do it, but two of the most standard are an IRA or a 401(k). Just like the health care and educational savings methods outlined above, both are tax-advantaged.
Individual retirement account (IRA)
There are two basic versions of an IRA: Traditional and Roth.
With a Traditional IRA, you pay taxes on the funds when you withdraw them. Most people use a Traditional IRA if they don’t have access to a 401(k) through their employer or if they’ve already contributed the 401(k) maximum and want to continue saving for retirement that tax year.
A Roth IRA is typically more popular with people earlier in their careers. That’s because the funds are contributed post-tax, which means you don’t have to pay taxes on your withdrawals in retirement. When you’re earning less and not actively looking for additional tax breaks, contributing post-tax dollars could make sense.
If you withdraw funds from your IRA before age 59 ½, the money will count as taxable income. Plus, it could incur an additional 10% tax.
The 2019 annual contribution limit is $6,000, or $7,000 if you’re 50 or older.
401(k) retirement account
A 401(k) retirement account is a plan offered through your employer that has the ability to include a company match to incentivize saving and act as an added benefit from your employer.
With a traditional 401(k), the funds are contributed pretax. It provides a tax advantage now by lowering your income, but you’ll have to pay taxes on the money when you withdraw it. With a Roth 401(k) the funds are contributed post-tax.
In 2019, for employees who participate in a 401(k) plan, the contribution limit is set at $19,000. You can withdraw your funds penalty-free after age 59 ½.
There are many different types of savings accounts that could benefit you. An ideal savings strategy can involve incorporating more than one.