What is a Savings Account and Why Do I Need One?
“What is a savings account?” may seem like a simple question, but the answer certainly isn’t.
While savings accounts are easy to use, there’s quite a lot to consider before using and choosing one to park your money in.
Savings accounts are a crucial piece to any personal finance portfolio. With this in mind, choosing an account that aligns with your goals comes with various factors to consider, as benefits and drawbacks can vary from one account to the next.
This WealthRocket article focuses on what a savings account is and provides details of what makes a good one. It also explains how to choose one as an American or Canadian citizen, with some insight into choosing the right one for your savings goals.
Table of Contents
What is a Savings Account?
Simply put, a savings account is a bank account dedicated to preserving and conserving money.
This type of bank account provides interest to the customer on a monthly, quarterly, or yearly basis. The higher the deposit is, and the longer it stays in the account, the higher interest earned. This allows account holders to earn money on their savings. Great interest rates compete with inflation.
The type of account does not facilitate daily or long-term use, such as spending on living expenses or long-term investing for life events such as retirement.
Instead, a savings account is better suited for short-term and long-term financial goals that might require quick withdrawal, such as an emergency fund, a vacation, or purchasing a home, for example.
Saving accounts do not come with a deposit limit, making them ideal for long-term or short-term savings. Money placed in a savings account is liquid, meaning the account owner can withdraw at their liking.
However, these accounts do not come with a debit card, nor do they usually offer free point-of-sale transactions.
Accounts typically come with a monthly or yearly transaction limit, depending on the bank or credit union issuing the savings account.
In the United States, deposit accounts come with $250,000 of coverage per account, meaning if the unlikely event that the bank or credit union that you do business with becomes insolvent, the FDIC will return your money for any amount below the coverage limit.
The same goes for Canadian accounts. In Canada, many banks come with CDIC protection of up to $100,000 per account. Canadian credit unions come with provincial coverage, which varies depending on the province’s credit union.
While these accounts do not generally offer incredibly high returns, like investment accounts, for example, they do keep up with inflation if it has a competitive interest rate.
What is a High-Yield Savings Account?
A high-yielding interest account is a savings account that can earn interest at a higher rate than a regular savings account. In Canada, a high-yield savings account is called a high-interest savings account.
Accounts that bear interest offer an Annual Percentage Yield (APY).
The difference between a high-interest or standard savings account comes down to how much interest the account pays the customer.
High-interest savings must pay over 20 times the national average of a conventional savings account.
In Canada, a high-interest savings account must offer interest exceeding 1.05%.
Certain accounts, such as a Money Market Account, combine a checking account and a high-interest savings account in the US.
In a Money Market Account, customers must maintain a minimum balance with limited withdrawal privileges per month, while maintaining a minimum balance to receive the high-interest payout.
How does a Savings Account Work?
A savings account is easy to use and requires little knowledge to operate.
Customers can open a savings account over the phone, in person at a branch, or online. Many online banks offer accounts that exclusively operate online.
Savings account owners can also make deposits into an account using the same methods or through the institution’s mobile app or website.
In most cases, customers require a checking account to deposit cash into a savings account. The checking account can be with the same or a different bank.
Some financial institutions offer hybrid accounts, which provide the flexibility of a checking account with a high interest rate.
While many free banking options are available, some institutions require monthly fees and restrictions when using a savings account. These accounts pay interest on a monthly, quarterly, or annual basis.
Banks and credit unions use deposits from customers and lend it to other customers at a higher interest rate. In return, the bank pays a portion of the interest back to the customer.
In the USA, any interest earned in any type of account is taxable.
In Canada, interest earned in high-interest accounts is also taxable. However, various registered accounts exist, such as the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). Both accounts allow Canadian citizens to earn tax-free interest.
What do you need to open a savings account?
Policies involving opening a savings account can differ from one financial institution to the next.
However, whether you live in the USA or Canada, opening an account typically requires some verification of identity. These typically include:
- Social Security Number / Social Insurance Number
- Two forms of identification (Driver's Licence, Passport, etc.)
- Proof of address (utility bills, etc.)
Forms of identification vary between each financial institution.
New accounts may also require the holder to make an initial deposit, depending on the bank or credit union that issues the savings account.
Frequently Asked Questions
High-yield denotes that the savings account provides a higher interest return than a basic savings account.
A savings account yielding high-interest must be 20 to 25 times higher than a regular savings account in the United States.
In Canada, high-interest accounts must provide interest higher than must offer an interest rate of 1.05% or higher to be considered a high-interest earning account.
Generally, persons should aim to keep their savings in a high-interest or high-interest savings account to maximize their interest-earning potential.
There’s no deposit too large or too small for a savings account. There are several things to consider regarding how much you should have in an account, however.
For instance, certain financial institutions may require you to open a savings account with a minimum deposit. In contrast, others require monthly or yearly contributions to keep the account or any of its perks.
Some banks or credit unions may have a maximum limit on the amount you can contribute to an account.
There is also insurance to consider. The FDIC in the United States covers $250,000 of insured deposits. In Canada, insurance coverage is up to $100,000 and varying for credit unions. This coverage supports an individual account, meaning if your deposit exceeds the coverage threshold, it is suitable to open a new account with any amount exceeding insurance coverage.
Not exactly. While saving and investing are quite similar, both methods of using money effectively but for different purposes.
The purpose of this account is to keep money on hand for the short term (and sometimes long term) goals or emergencies. It is most suitable for an emergency fund or a specific savings goal, such as a vacation or a car. Essentially, accounts are for regular savings contributions and come with no risk or volatility.
On the other hand, investing is meant for cash earning or the long term, such as home ownership or retirement, for example. The idea is that the person will place the money with some risk if it leads to the investment growing over time.
There are, however, some types of investments that closely resemble interest-bearing accounts, such as a Certificate of Deposit (CD), for example.