Savings Account Pros and Cons

What you should know before opening a saving account

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Once you start to work on your nest egg, you may wonder where you should keep it. With a wide variety of interest-accruing accounts on the market, what type will offer you the most in return? Savings accounts are often the first resort—but are they the best? Here’s a look at some savings account pros and cons, along with four alternatives worth considering. 

Savings Account Pros and Cons

Pros
  • Earn interest

  • Easy to open

  • Accessible funds

  • FDIC-insured

  • Low risk

Cons
  • Fees

  • Low annual percentage yields (APYs)

  • No tax benefits

  • Account restrictions

  • FDIC insurance is limited

Pros of Savings Accounts Explained

Earn interest: Savings accounts can offer you returns on the money you deposit. Traditional savings accounts typically offer a modest APY, while online-only savings accounts often offer much higher APYs—sometimes 10 times as high as a traditional account.

Easy to open: Savings accounts are often easy to open. In many cases, you can apply and complete the process online within a few minutes. 

Accessible funds: Savings accounts provide easy access to the funds in your account. The money stays liquid and isn’t subject to a specific term like it is when it’s in a certificate of deposit (CD). You can often manage your money online and schedule transfers or withdrawals as needed (although withdrawals may be limited). 

FDIC-insured: As long as you choose a federally insured bank or credit union, the money in your savings account will be insured up to $250,000. That means if the institution goes bankrupt, your money won’t be lost. 

Low risk: Some types of interest-earning accounts require you to take risks to earn returns. Savings accounts offer returns without the risk of losing your money. 

Cons of Savings Accounts Explained

Fees: Financial institutions may charge fees for savings accounts that can defray your earnings. For example, a monthly fee may be charged if your balance drops below the minimum balance requirement for the account. 

Low APYs: With the low risk of savings accounts comes modest returns. Compared to other interest-yielding options like CDs, savings accounts will often have lower APYs.

No tax benefits: The interest you earn from your savings account is taxable in the year it’s paid.

Account restrictions: Savings accounts often have restrictions, such as minimum balance or deposit requirements, withdrawal limits, and limited deposit or withdrawal methods. For example, to get a certain APY, you may need to deposit a minimum amount in the account. Further, you may be limited to six penalty-free withdrawals per month. 

FDIC insurance is limited: If you plan to keep more than $250,000 in an account, any amount above $250,000 won’t be protected by federal insurance. 

Savings Account Alternatives

While a savings account can be a good place to start, another type of account might be a better fit or a good additional account. Here are some alternatives to consider. 

Money Market Accounts

A money market account (MMA) is another type of savings account offered by banks and credit unions that is often insured by the federal government up to $250,000. MMAs are known for higher APYs and minimum balance requirements than traditional savings accounts. However, some high-yield savings accounts are now beating MMA rates without requiring such high balances. According to an FDIC report from January 2022, the average APY for MMAs is about equal to the average APY for traditional savings accounts.

Certificates of Deposit

A certificate of deposit (CD) is a type of savings account where you deposit a specific amount of money into the account for a set term to earn the APY. For example, a 12-month CD with a 0.14% APY would require you to keep the money in the account for 12 months to earn the interest. Typically, the longer the term, the higher the APY. However, if you withdraw your money early, you often have to pay an early withdrawal penalty or forgo your interest earnings. While longer CDs may offer higher returns than a savings account, you’ll need to leave the money in the account for a set amount of time to reap the full benefit.

Low-Risk Bonds

Putting your money into Treasury or municipal bonds is riskier than stashing it in a savings account, but it’s still relatively safe compared to investing in other kinds of bonds due to government backing. And the returns may be better than with a savings account.

Treasury bonds pay a fixed interest rate every six months until they mature, and are issued in terms of 20 or 30 years. These can be purchased through the U.S. Treasury Department website or from a bank, broker, or dealer. 

Municipal bonds, which are issued to finance the daily obligations or capital projects of a city, county, or state government entity, allow you to lend money to the issuer in exchange for regular interest payments. The bond’s maturity date depends on its duration; short-term bonds mature in one to three years, while long-term bonds often won’t mature for more than a decade. Interest rates on municipal bonds fluctuate; however, they generally follow the broader bond market.

Interest on municipal bonds is often exempt from federal income tax and may be exempt from state and local taxes in the state in which it was issued.

Peer-to-Peer (P2P) Lending

The popularity of peer-to-peer lending platforms translates into a unique opportunity for you to earn a higher rate of return on your money than you would in a savings account. These sites match individual borrowers with individual lenders and offer accounts for investors that can be opened with as little as $25. Your investment will be used to fund personal and business loans, with yields that can range into the double digits, depending on the risk profile of the borrower. 

The rate of return should be factored in with the risk—these are unsecured loans—but they can be a good alternative to a savings account.

How To Use a Savings Account

A savings account is often a good first step when you start saving money. It’s safe and is a good place to build an emergency fund. If you decide a savings account is right for you, be sure to shop around to find the one that’s best for your situation. Look for minimal fees, a high APY, suitable account requirements, and good customer service. 

Once you have a six-month emergency fund in place, it can be advantageous to diversify. Explore other savings vehicles that offer a higher rate of return, but may be a little less liquid or riskier. In addition, you may opt to put an additional portion of your income toward retirement savings in even riskier investments that have much more upside potential. With time on your side, stocks, bonds, and mutual funds in tax-advantaged accounts such as a 401(k) or Roth IRA can yield tax benefits now with the potential for greater distributions in the future. 

Frequently Asked Questions (FAQs)

How does interest work on a savings account?

With a savings account, interest works in your favor to help you earn money on the money you deposit. Financial institutions feature an annual percentage yield (APY), which tells you how much you’ll earn per year. For example, a 1% APY means you’d earn $1 per year in simple interest for every $100 you keep in the account. However, you may earn more if an account offers compounding interest, which enables you to earn interest on the interest you earned—the more frequent the compounding, the more you earn. 

What is the difference between a savings account and a checking account?

While there are several differences between checking and savings accounts, the main one is that checking accounts are made for more frequent use while savings accounts are designed for money you don’t want to spend. 

Before 2020, federal law restricted savings accounts to six withdrawals per month, but that’s been put on pause since the pandemic began. Another difference is that savings accounts more commonly offer to pay you interest on the account balance while checking accounts typically do not. 

How much money should I have in my savings account?

The rule of thumb when figuring out how much money you should save is to aim for at least enough to cover your living expenses for three to six months—more if you have a high income or it would take you a long time to find a job if you lost yours. Having an emergency fund of this size in place can help to ensure you have a cushion if an unexpected event occurs that cuts off your income. Beyond that, the more you can save for other goals such as a home or retirement, the better. Check your budget to see how much you can save after all your mandatory expenses. 

Article Sources

  1. National Credit Union Association. “How Your Accounts Are Federally Insured,” Page 1.  Accessed Feb. 8, 2022.

  2. FDIC. “What We Do.”  Accessed Feb. 8, 2022.

  3. IRS. “Topic No. 403 Interest Received.” Accessed Feb. 8, 2022.

  4. FDIC. “National Rates and Rate Caps.” Accessed Feb. 7, 2022.

  5. Bloomberg. “United States Rates & Bonds.” Accessed Feb. 8, 2022. 

  6. U.S. Securities & Exchange Commission. “Municipal Bonds.” Accessed Feb. 8, 2022. 

  7. U.S. Government Accountability Office. “GAO-11-613: Person-to-Person Lending: New Regulatory Challenges Could Emerge as the Industry Grows.” Accessed Feb. 8, 2022. 

  8.  Federal Register. ​​”Federal Reserve Board Announces Interim Final Rule To Delete the Six-Per-Month Limit on Convenient Transfers From the ‘Savings Deposit’ Definition in Regulation D.” Accessed Feb. 8, 2022.