Different Types of Savings Accounts
Considering a savings account but not sure which option to choose? There are many different accounts available and it’s easy to feel a little overwhelmed by the choice, especially if this is your first foray into the world of long-term savings.
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Fortunately, saving your money couldn’t be easier regardless of the method you choose and your cash could create a brighter and more prosperous future.
Traditional Savings Account
A basic savings account is simply a place to hold money that generates a rate of interest based on your money and the length of time it remains in the account. You will be given access to your funds when you need them, but you may face penalties if you withdraw money frequently and there are also caps on how many times you can withdraw.
Traditional savings accounts are a great option if you want a simple way to secure your money and earn some extras cash on the side. But there are better options available for most consumers, all of which are a variation of a traditional savings account.
A traditional savings account, and all savings accounts for that matter, are secured for up to $250,000 per account holder. If you have $100,000 in the account, for instance, and the bank or credit union folds, then you will get your money back.
Certificates of Deposit
Known simply as a CD account, these savings accounts require you to lock your money away for a specific and predetermined period. This can range anywhere from a few months to a few years and it’s an ideal option if you’re saving for a specific purpose and won’t need that money anytime soon.
You will be offered a higher interest rate on average, but if you withdraw your money at any time you will face a penalty. These accounts need to be shut away and forgotten about. Save only the money that you definitely won’t need and create an additional emergency fund just in case.
Jumbo Savings Account
A jumbo savings account is aimed at high earners with a lot of money to invest. Traditionally, that sum was $100,000, but many banks and credit unions have lowered the benchmark.
Many of these accounts have merged with traditional savings accounts, offering the same high rates and benefits and with minimum deposits as low as $5,000. But there are still a number of credit unions offering an additional 0.5% to 1% for those investing close to 6-figures.
If you have a high sum to invest, don’t simply assume that a jumbo savings account will offer you the best rates.
Take a look at traditional savings accounts as well. No self-respecting financial institution is going to prevent you from depositing more money into a smaller savings account. It’s how they make their money, and more is always better.
529 Savings Accounts
A 529 plan can help you save for college expenses, including tuition, board, and other costs you accumulate during this time. The money can grow tax-free providing the sum is only used for educational purposes.
You don’t need to be a full-time student to open one of these accounts and can create one even as a part-time student.
Rewards Savings Account
A rewards account is simply a savings account that offers additional benefits as soon as you sign up. These benefits can include cash back sums and gifts. However, rewards are designed to tempt you into an account that may not offer the best terms.
Make sure you compare these benefits to one with a higher interest rate and calculate which one will provide you with the most benefits throughout the term.
Joint Savings Account
A joint savings account is merely a savings account held by two individuals. They can both add money to the account and withdraw as per the terms. However, the only real benefit is the fact that the FDIC insurance amount doubles from $250,000 to $500,000 on account of there being two account holders. However, it’s highly unlikely that this will ever come into play.
These accounts are still a great way for couples to invest in their own futures. Two incomes are better than one and if you both commit to adding what you can, when you can, the account will grow greatly, swell with interest, and allow you to cover a sizeable expense.
Individual Retirement Accounts and 401(k)
An Individual Retirement Accounts, or IRA, allows you to deduct several thousand dollars a year and earn a tax-free income for your retirement. However, as soon as you make a withdrawal it will be subject to income tax and if you withdraw before a specific age you may face a severe penalty.
A 401(k) can also help you save a sizeable sum of money for retirement. You can add some of your pre-tax income to the plan and some employers will match your contributions with their own contributions. As with IRAs, you will be subject to income tax when you withdraw and maybe hit with a large penalty if you cash in before your time.
How to Use Your New Savings Account
A savings account may not offer the highest return on your money, especially when you compare it to the money you could earn through investments like stocks and bonds. However, unlike those investment options, a savings account comes with a minimal (virtually nonexistent) risk.
And it’s not all about the interest.
Think of a savings account like a piggybank. You put money into it whenever you can and even though investing that money doesn’t impact your life or your finances in a significant way, when you eventually pop the silicon cap and tip the balance out, you’ll discover that you have twenty bucks you didn’t know you had.
The act of moving money out of your immediate vicinity and tucking it away for another day is what makes these accounts so effective. Yes, it’s your money, but it’s money that may have otherwise been frittered away on unnecessary expenses, as opposed to money you would have put to good use.
As an example, let’s imagine that, instead of investing your grandmother’s $5,000 inheritance on a brand-new vacation five years ago, a vacation that ended in misery when you came back with little more than sunstroke and gastroenteritis, you placed it in a savings account.
Now, let’s imagine that you followed this with a small investment of just $50 per month. With just a 2% rate of interest, that sum would now have grown to over $8,600. If you had increased that to $200, an affordable sum for most American households, it would be worth more than $18,100.
It’s a rainy-day fund, a “transfer and forget” account that moves money out of spending range and into a place it can grow and, at a later date, be put to good use. In this way, rather than being blown on a vacation and a few extra luxuries every month, your savings account could be used for:
A Down Payment
The average Millennial needs to save for over 14 years to cover the cost of a 20% down payment. On top of that, they’ll also need to pay closing costs, moving fees, and the many other expenses that can arise during this time.
If you want to buy your first home, you need to start saving as soon as possible. Even if you don’t save enough to cover the full down payment, the more you pay, the lower the interest rate and balance will be.
The Vacation of a Lifetime
While we always warn against throwing your money away on regular vacations when you have debt and responsibilities, you still need to have fun and to create those memories. Everyone has an idea of what their favorite vacation will be and with a savings account, you can start saving for it.
Whether you’re saving a few thousand dollars for a week in Rome, London or Paris, or you’re saving a 5-figure sum for a cruise or a long vacation in Australia, a savings account can help.
Every family needs an emergency fund to prepare for a rainy day. This fun can protect you against unexpected financial expenses and ensure that you don’t fall into the red just because your car needs fixing or you’re required to cover a loved one’s funeral costs.
Where emergency funds are concerned, it’s important to make sure you can withdraw your money when you need it and that it won’t be tied to the account for several years.
Education is expensive in the United States, costing an average of between $30,000 and $40,000. Many college students simply can’t afford to cover the cost themselves, and their credit scores are often too low to get a favorable loan, so they turn to their parents and grandparents.
By preparing for this big (and expensive) day in advance, you can avoid the high-interest rate loan and cover some or most of the cost in full. And if your child decides they don’t want a college education, you can put it to use elsewhere.
How Can Banks Make Money from Savings Accounts?
When you open a savings account, the bank keeps your money safe and secure and offers you a rate of interest to allow your money to grow. But if they’re doing all the work and paying you money, how can they possibly make a profit?
It’s actually quite simple. Banks are in the business of loaning money and charging high-interest rates.
When you open a savings account, you increase their assets and allow them to loan more money to other customers. They will always make more money than they spend because the APR they charge on a loan is much higher than the one they give you on your savings account.
That doesn’t mean they are literally taking the money out of your account, giving it to someone else and then making you responsible when that lender defaults. Your money is actually secured by the Federal Deposit Insurance Corporation (for banks) or the National Credit Union Administration (for credit unions). If they go out of business, you’re covered for up to $250,000.