Savings Accounts: What Are They And How Do They Work?

A savings account is different from a checking account, which is what you usually draw from with your ATM/debit card. A savings account is also separate from an investment account, like a 401(k) or an IRA, which are meant for long-term wealth building and involve more risk.

Let’s discuss how to set up a savings account, how it works, and why it is a valuable resource for your personal financial management.

What Is A Savings Account?

A savings account earns interest and is used for storing funds that you don’t need daily, but may need quickly access to a few times a year. Available at banks and other financial institutions, savings accounts are excellent for everything from developing an emergency fund to handle unexpected expenses, to saving for large purchases, and even saving for retirement.

How Do Savings Accounts Work?

The main difference between savings and checking accounts is that a savings account earns interest, where checking accounts usually don’t. Interest is paid as a percentage of the total amount in your account and is automatically added into the account balance to make it grow. It is what the bank, credit union, or online lender pays you in exchange for the ability to use your funds to invest in other businesses that need capital. The bank will tell you the amount you can earn in a year on your interest-bearing savings account as your annual percentage yield (APY).

In terms of depositing or withdrawing funds, a savings account is not always as easy to access as your checking account. That said, many people have their savings account side-by-side with their checking at the same financial institution and can access both with their ATM/debit card. Withdrawing from savings or transferring funds between checking and savings can usually be done at the ATM, with some restrictions. A savings account can also be managed online or through a mobile app.

For people who receive their paycheck through direct deposit, they can usually direct a percentage of each paycheck directly into savings. A savings account also has significant protection. By law, savings accounts are federally insured up to $250,000 – meaning that if your financial provider goes out of business, you still hold the possibility to recover funds, up to this maximum limit.

Savings Account Pros And Cons

Savings accounts are one of the most common forms of banking used by millions worldwide every day. Sometimes a person will have their first savings account set up by their parents when they are still a child so they can start building savings from a very young age. Once you have deposited money into a savings account, however, there are some key differences from a checking account, which provides instant access to your funds.

While you will always have access to all of the money in your savings account, some savings accounts may be subject to withdrawal limits, transfer limits, or even penalties if a monthly number of transfers or withdrawals is exceeded. If it’s an online savings account, withdrawals may also take slightly longer.

Because it is in your (and your bank’s) best interest for you to establish and maintain a good balance in your savings account, there may be a minimum deposit to open one and a minimum balance to keep it open. Some savings accounts also have monthly charges and maintenance fees, and the interest paid on money in a savings account is often much lower than investment accounts — though they offer a much lower risk than most investment vehicles.

Whatever financial institution you consider working with (especially if it’s an online bank without local branches or ATMs), be sure to ask how transfers and withdrawals work. Such arrangements may require you to transfer funds to a traditional bank account before money can be withdrawn, or restrict you to using only certain banks’ ATMs, potentially limiting how quickly you can access funds.

A savings account is a tool for you, the saver, that provides a safe place to keep money and reduce the temptation to spend. However, you have the option to close the account or transfer funds to another account or institution at any time.

Below is a list of other pros and cons to consider when selecting or opening a savings account:

Savings Account Pros

• FDIC insured:  The Federal Deposit Insurance Corporation (FDIC) is a U.S. government-backed insurance program that protects your savings account funds 100% up to $250,000.
• Interest-bearing: A savings account pays interest, allowing your money to work for you by growing over time.
• Low deposit requirements: Savings accounts sometimes have a minimum deposit requirement. This is usually quite low and can often be $0, particularly if you maintain other accounts with the same institution.
• Overdraft protection: Some savings accounts can provide overdraft protection to a connected checking account if the checking account becomes overdrawn.
• Reduced temptation: By placing funds into a separate account from the one you use to buy goods and pay bills, you’ll be less tempted to overspend.
• Easy to make deposits: You can easily deposit funds into a savings account at a branch or ATM, online via a transfer, or even by sending a photo of your deposit check through a mobile app.

Savings Account Cons

• Transfer limits: The number of transfers and withdrawals may be limited within a certain time period.
• Minimum balances: Some savings accounts require that you maintain a minimum balance and/or that you make a minimum contribution within a certain time period.
• Limited access: Access to your funds may not be as easy as a checking account, and the account may not come with a debit card or checks.

Getting The Most Out Of A Savings Account

While it may be convenient to have your savings at the same institution as your checking account, if you want to get the most out of your savings account, you would be wise to shop around for the type of account that works best for you.  

With most accounts, you can make automatic deposits to your savings. If you currently have your pay deposited directly to your checking account, you can also have a portion sent to your savings account. Or set up your checking account to make regular, automatic transfers to your savings. With a Smart Savings account from Rocket Money^SM, you choose the amount you want to transfer and how frequent you want the transfers to take place – Rocket Money does the rest. You can change these factors at any time.

Advantages Of Online Savings Accounts

In addition to the traditional savings accounts you can set up at a local brick-and-mortar bank or credit union, online savings accounts typically offer all sorts of helpful perks, such as higher interest rates and lower expense charges and fees. At the same time, they may also provide less immediate access to money and offer less face-to-face customer service interaction.

On the bright side, many online lenders are now finding ways to offset challenges associated with a lack of physical presence by offering access to networks of partner ATMs and banks, and reimbursing fees associated with using them. These benefits have led to a huge surge in popularity in recent years, with online banking solutions quickly becoming a popular alternative to traditional savings accounts.

Alternatives To Savings Accounts

Just as there are many financial providers – banks, credit unions, online fintech companies, etc. – that offer savings accounts, there are many types of savings accounts available. Many will offer a higher rate of return than a traditional account, but they will have their own set of restrictions which may or may not jibe with your financial planning. Check out some alternatives to a traditional savings account:

High-Yield Money Market Accounts

High-yield savings accounts are common nowadays. If you’re considering opening one, it may help to know that it’s a form of savings account which offers a higher annual percentage yield (APY, or interest rate) than traditional savings accounts. When it comes to savings accounts, generally the higher the APY, the faster your money will grow. Some key differences from online savings accounts (which also offer a high APY) are that most money market accounts require a higher minimum deposit and use a variable interest rate that is subject to market fluctuations. A money market, however, is still FDIC-insured up to $250,000.

Certificates Of Deposit (CDs)

CDs are essentially a form of time-deposit savings account that offers higher interest rates than most savings or money market accounts, as well as a guaranteed rate of return. You can set up a CD with most any bank, credit union or online lender. Under the terms of a CD, you’ll agree to make a lump sum deposit and leave these monies in the account for a predetermined period of time (for example, 6 months or 1 year). Individual financial institutions that you bank with will determine the rates, payouts and terms offered, as well as what penalties may be imposed if you choose to withdraw funds earlier than agreed. As with savings accounts, CDs are federally insured, and considered to sit on the lower end of the investment risk spectrum compared to stocks and bonds.

High-Yield Checking Accounts

A high-yield checking account acts exactly like a regular checking account, but it also pays interest like a savings account, typically at a higher APY. The account holder will have instant access to funds through a debit card and checks. This is sometimes called a rewards account because it encourages account holders to keep a higher balance in their checking account, in return for different rewards like discounted or waived ATM fees. Often, you will need to meet a minimum balance to qualify for this kind of account.

Health Savings Accounts

A health savings account (HSA) provides savvy investors with a means to save for medical expenses while also reducing their overall taxable income. In general, an HSA works like a personal savings account; however, monies that are saved within it can only be used for qualified health care expenses. Contributions into an HSA lower your taxable income, helping save you money at tax time. HSA funds not used in a calendar year roll over to the following year. HSA funds also accrue interest like a regular savings account.

Best Savings Accounts for 2023

We’ve researched some of the best savings accounts for 2023:

Savings Account FAQs

How do you open a savings account?

Start by researching financial providers online and reviewing terms, conditions and interest rates. Your homework will quickly reveal a host of savings account providers who can help pair you with opportunities. To open a savings account, you’ll need to provide documentation verifying your identity and other personal details, submit an application, and fund the account with a deposit. You may also need to sign up for an online banking account and services.

How Many Savings Accounts Should I Have?

The answer will be different for everyone. Most people just need one savings account that pays a competitive rate and is relatively easy to access when you want to make a withdrawal, deposit, or transfer. However, it is generally best practice to keep at least one separate savings account for emergency funds only.

Others like to have multiple accounts — a travel fund, education fund, charity fund, etc. As long as you live consistently within a budget, this can be a great way to save for various goals, especially if these funds are direct deposited.

Which savings account type will earn you the most money?

If you shop around, you’ll find that the types of savings accounts that earn the highest interest are certificates of deposit (CD) or money market accounts. The bank will pay more because these accounts restrict your access to funds or require a much higher minimum balance, or both. And keep in mind that rates fluctuate frequently.

With a CD you’ll be required to make a minimum deposit and leave it for a period of time, usually at least 6 months to a year. The rates may be better the longer you agree to leave your deposit, but there are penalties if you make a withdrawal before the time period is up.

Money markets can pay a higher rate and even allow you to write checks, but they also require a higher minimum balance. Money market accounts are often a good choice for people who have a significant amount of money to invest in savings.

Can you write checks from an online savings account?

No, federal regulations prohibit you from writing checks from your online savings account. You can link your savings account to another checking account, however, and easily transfer funds. This can be done by providing a routing number and account number to your checking account. Some online savings accounts may put a limit on the number of transfers allowed in a certain time period.

Are savings accounts and online savings accounts FDIC insured?

Yes. Whether you set up a savings account with a neighborhood bank or credit union or through an online lender, all of these traditional accounts are insured for up to $250,000 by the U.S. government should anything go wrong with the institution.

The Bottom Line

For anyone who has room in their budget to save for a rainy day or a specific goal, there are countless lending institutions available to help start a savings account. And they all offer several different types of accounts, each designed to meet the needs of various types of investors. While most savings accounts do not allow you to write checks, they can be easily linked to a checking account when you need to make an emergency withdrawal.

Ready to get saving? Download the Rocket Money app to start saving automatically and track all of your financial activities on the go.