What is a savings account and how does it work?

What is a savings account?

A savings account is a type of bank account that allows you to deposit money and earn interest on your overall balance. Some banks will have deposit minimums, which require you to deposit a certain amount in order to open the account. The interest you earn will be higher than on a checking account, but lower than on a high-yield savings account. The specific rate will vary based on the institution and account size, so be sure to check the fine print before opening the account.

In addition, most banks and credit unions are Federal Deposit Insurance Corporation (FDIC)- or National Credit Union Administration (NCUA)-insured, which provides a level of safety for your money up to a certain amount (typically $250,000 per depositor).

Money stored in a savings account isn’t always available for immediate use, and the account might not have check-writing or ATM withdrawal capabilities.

How do savings accounts work?

After you initially open the account, you’ll fund it with your first deposit. This deposit can come from a wireless bank transfer or physical transfer, such as a check or cash. You can continue to fund the account while also using other options, like direct deposits from an employer.

While you can continue to make deposits, there are sometimes regulations on how many withdrawals you can make. Banks may limit withdrawals from a savings account to a specific number per month though the exact number may vary by bank. Many banks will impose a fee on clients who attempt to exceed that limit.

The money that is in your savings account accrues interest based on your annualized interest rate. If you were to deposit $1,000 dollars into a savings account that pays 1% interest compounded annually, you would receive $10 dollars in interest at the end of the first year.

How to choose a savings account

If you’re interested in opening a savings account, there are some important features to look for. Below are some of the most common features of savings accounts that you should compare in order to find the one that’s best for your needs:

• Rates: The most important part of any savings account is the interest rate your money earns. Be sure that the rate being offered is the most competitive, so that your money has the best ability to appreciate in value.
• Fees: Also important are the fees attached to the account. If the fees you incur are higher than the interest the account earns, it’s possible to lose money in a savings account.
• Minimum deposits: Depending on the financial institution and account, minimum deposits can vary. Savings accounts with higher interest rates may require higher deposits, though many online banks waive minimums altogether.
• Withdrawal limits: As noted above, different banks will set different restrictions on account withdrawals. Whether you are establishing the account with a specific purpose in mind, or just to serve as your main savings account, you should keep account restrictions in mind.
• Accessibility: Consider if the account is offered by an online bank or a brick-and-mortar bank. If you want the ability to make deposits and withdrawals in person, online banks may not be the best fit for your needs.

» MORE: Best online savings accounts

How to open a savings account

The main ways to open a savings account are by going in person or by applying online, though some banks will also allow you to apply over the phone or via regular mail. Once you determine how you want to apply, you need to gather the necessary documentation, including:

• Your name
• Proof of address
• Phone number
• Date of birth
• Social Security number
• Email address

Identifying documentation, such as a valid government ID, is necessary for verification. You will also need to state whether the account will be held by more than one person. Before you submit the application, be sure to read the terms and conditions to be sure that there are no surprises after it is opened.

Many banks will also require that you make a minimum deposit when opening an account, so be sure to check the specific requirements of your bank or credit union.

» MORE: What do you need to open a bank account?

Alternatives to savings accounts

In the event that your goals and needs require something different, or you’re simply curious about your other options, there are multiple alternatives to savings accounts. The most common include:

• Money market accounts: A money market account (MMA) has the features of both a savings and a checking account. The interest rate is similar to that of a savings account, but the debit card and check-writing privileges are similar to that of a checking account. MMAs are also insured, providing the same level of safety as traditional savings accounts.
• Certificates of deposit: A certificate of deposit (CD) is a type of savings account that locks your funds in for a set period of time. Similar to bonds, CDs are offered in a variety of time durations, allowing you to pick the one that works best for you. Be aware that you can’t make early withdrawals easily from this type of account; withdrawals made before the end of CD term may result in fees and penalties.
• Cash management accounts: Cash management accounts are generally offered by nonbank financial institutions. Cash management accounts often share some features of checking accounts, such as check-writing privileges and a debit card. CMAs can also be linked to your brokerage account, allowing for easy transfers between accounts.
• High-yield savings accounts: A high-yield savings account pays significantly more interest than the average savings account. Many companies claim to offer more than 10 times the average amount. These accounts will generally have higher minimum deposit requirements than traditional savings accounts and the same withdrawal limits.

Bottom line

Savings accounts provide a useful, low-risk way to save money. Depositing funds into an FDIC- or NCUA-insured institution protects your money against losses up to $250,000, giving you peace of mind.

There are different types of savings accounts, as well as a number of alternatives, so it’s important to compare all your options after outlining your specific needs and goals. There is no universally correct approach to take — only the one that’s best for you.