Savings accounts are one of the most popular types of bank accounts, but a lot of people can’t answer this simple question: How does a savings account work? For the most part, they’re pretty straightforward. You invest money, your bank pays you interest, and you can withdraw money when you need it.
But if you want to get the most out of your savings account, it helps to have a more detailed understanding of how savings accounts work. Here is a brief overview.
How do savings accounts work?
If you know anything about how savings accounts work, you probably know that they are designed to hold extra money that you don’t need right now. Banks use your funds to make loans to other customers, and they encourage you to keep your money in the bank by offering you interest on your balance.
Because they depend on a stable source of funds to operate, banks limit you to six “convenient” withdrawals per month from a savings account (per Regulation D). Convenient withdrawal is any method that does not require you to get in your car or make a call. The government deviated from this rule during the pandemic, so for now you can withdraw money as often as you want, but it won’t last forever. Your deposits are always unlimited.
Savings accounts allow you to move money by wire transfer and wire transfer. You can also go to a bank branch to deposit, transfer or withdraw funds. Some savings accounts may also allow you to withdraw money using an ATM card or check, but this is rare. Often times you need to transfer money to a checking account to withdraw money or write a check.
How does an online savings account work?
If you know how savings accounts work, you also have a very good understanding of online savings accounts. The main difference is that online banks don’t have a physical location, so you can’t access your funds in person. Instead, you use online tools like apps or websites for your banking needs. The upside is that online financial institutions can afford to offer you higher interest rates than traditional banks because they don’t have to embezzle funds to maintain branches.
Online savings accounts also tend to have lower fees than traditional savings accounts, and they usually don’t have minimum balance requirements. If you’re trying to avoid a monthly fee or minimum balance requirement, opening a savings account with an online bank is a great way to start.
How does interest work on a savings account?
One of the main points of confusion about how savings accounts work is how banks calculate interest on a savings account. Each account has an annual percentage return (APY). Most people think it’s the same as an interest rate, but the APY is actually slightly different.
APY tells you how much your balance should increase after one year. If you have an APY of 1%, that means your $ 1,000 balance will be worth $ 1,010 at the end of the year, assuming you don’t deposit or withdraw any additional funds. The calculation becomes complicated if your balance changes over time or if your bank changes its APY, which it can do when it wishes.
Interest on savings accounts is usually compounded daily. So your daily interest rate would be your APY divided by 365. On the first day, you only earn interest on your initial balance. But on the second day, you earn interest on your initial deposit plus any interest you’ve earned so far. Compound interest helps your savings grow faster. Your bank usually deposits all the interest you have earned into your account once a month.
Are savings accounts safe?
A common concern that people have when learning about how savings accounts work is whether they are safe. If you are familiar with banking terminology, you might ask yourself, “Are savings accounts FDIC insured?” The answer to both is yes.
Insurance from the Federal Deposit Insurance Corporation (FDIC) is an essential part of the security of your savings account. It protects you up to $ 250,000 per person, per account and per bank in the event of bank failure. All reputable banks have FDIC insurance on their deposit accounts, including savings accounts.
Banks also use advanced encryption on your online accounts to ensure identity thieves do not gain access to your financial information. Of course, the security of your savings account information is also up to you. Be careful not to leave your passwords or bank account information where someone might find them, or they might be able to access your funds remotely.
If you have extra cash that you don’t plan to use right away, a savings account can be a good place for it. If you’re aiming for a savings goal, keeping your funds in a personal savings account can help you track your progress.
Now that you understand how savings accounts work, you can find the right one for you. Focus on choosing an FDIC insured account that charges low fees and has a high APY so that you can earn the most interest on your money.