Advantages of savings account include keeping your money safe, quickly withdrawing cash when needed, and earning interest. Disadvantages of savings account include monthly withdrawal limits, substantially lower returns than other accounts, and interest rate fluctuations.
What Is a Savings Account?
A savings account is a type of deposit account. You open one at a bank, credit union, or other financial institution.
There are a few types of savings accounts:
Most people have a traditional or regular savings account. These accounts are typically opened at the same bank where you have your checking account. Sound familiar?
Also, a savings account is an interest-bearing account which means you get paid interest for simply keeping money in the account.
Let's move onto to the advantages and disadvantages of a savings account.
Advantages of Savings Account
There are many advantages of a savings account. The following are five savings account advantages.
The Federal Deposit Insurance Corporation (FDIC) is a government agency that guarantees a certain amount of money if your bank or financial institution were to go out of business.
The FDIC insures up to $250,000 for individual accounts and $500,000 for joint accounts.
So what does this mean exactly? Let's say you have a checking and savings account at Chase. You have $275,000 in your savings account and $25,000 in your checking account. In total, you have $300,000 at Chase.
If Chase were to go out of business, which is highly unlikely, you'd be guaranteed a total of $250,000 regardless of the number of accounts and balance of each bank account. So, if you plan on keeping more than $250,000, open an account at a different bank.
To learn more, check out the FDIC Deposit Insurance FAQs page.
Takeaway: Only open accounts at FDIC-insured banks.
Liquidity is the ability to quickly turn money into cash.
Let's face it, things happen. When you quickly need cash, instead of charging it to your credit card or having to take out a loan. You can quickly withdraw from a savings account.
Takeaway: Cash is available within minutes.
3. Withdrawal Limitations.
Per federal regulations (although during COVID that's no longer the case), you're only allowed six withdrawals every month.
Yes, the government has decided that you can only make six withdrawals from your savings account every month.
What happens if you make more than six withdrawals in a month? Your bank will charge you a fee. If it happens regularly, your bank can turn your savings account into a checking account. Checking accounts don't have withdrawal limitations.
At this point, you might ask, why is a limitation on withdrawals an advantage? Because you shouldn't be withdrawing more than six times a month anyhow.
A savings account should be used for emergencies and unexpected expenses, for the most part, that doesn't happen every month and definitely not more than six times a month.
If you withdraw more than six times a month, you're charged a penalty fee and that alone can be an incentive not to go over the limit.
Takeaway: A penalty is an incentive not to withdraw more than six times a month.
4. Free to Open or Close.
Opening a savings account is typically free. If the bank or financial institution you are opening your savings account with tries to charge you a fee, definitely search for other options because 99% of banks don't.
Also, it doesn't cost anything to close a savings account so you have nothing to lose if you were to change your mind after opening one.
If you do happen to close your savings account, all you have to do is withdraw your money or transfer it to another account and communicate to the bank that you are closing it to ensure you don't incur fees.
Takeaway: Opening a savings account is free!
5. Earn Interest.
Savings accounts are interest-bearing accounts which means you earn and are paid interest on the balance. Traditional or regular savings accounts have the lowest interest rates.
If you have a traditional savings account, you know what I mean. You literally get paid cents on a thousand dollar plus balance. There is however a thing called a high-yield savings account. A high-yield savings account earns a significantly higher interest rate than a traditional or regular savings account.
The main difference between the two is that a high-yield savings account is opened at an online bank which means they don't have physical locations. For the most part, that shouldn't be a problem. When you're ready to withdraw from your high-yield savings account, all you have to do is transfer the money to your checking account.
Your high-yield savings account does not have to be in the same bank as your checking account to process a transfer.
Why do high-yield savings accounts pay a higher interest rate? Because unlike traditional banks that have to pay for buildings, employees, ATMs, etc., online banks simply don't have those costs so they can afford to pay a higher interest rate.
Takeaway: Get paid for simply keeping money in a savings account!
Disadvantages of Savings Account
Although there are many advantages of a savings account, there are also a few disadvantages. The following are four disadvantages of savings account.
1. Interest Rates Fluctuate.
Earning interest on a savings account is great but there's one caveat. The interest rate is not fixed, it fluctuates (changes).
Interest rates go up and down. The interest rate when you open a savings account can and will most likely change. Interest rates are regulated by the government and multiple factors determine whether it goes up or down so it's almost impossible to predict the rate.
Takeaway: Interest rates are not fixed, rates go up and down.
2. Low Returns Compared to Other Accounts.
Although a savings account is not an investment account. It's important to compare the two. A savings account is a great option for an emergency, vacation, or holiday fund. However, the interest you earn is nothing compared to keeping your money in an investment account. Both accounts are important to have but I recommend that you don't keep all of your savings in a savings and or checking account for example.
Historically speaking, investment accounts earn an 8% return every year. Savings accounts, specifically high-yield savings accounts, which earn the highest interest, earn less than a 1% return every year.
A $25,000 balance in a high-yield savings account can earn, on the high end, about $150 one year.
A $25,000 balance in a retirement account can earn, historically speaking, about $2,000 one year.
When you see the numbers in black and white the answer is pretty clear.
Takeaway: Don't keep all your savings in a savings account.
Liquidity is the ability to quickly turn money into cash.
Liquidity is both a savings account advantage and a disadvantage. It becomes a disadvantage when you can't commit to only using your savings account money for emergencies or for whatever you're saving for.
It can become too easy to withdraw money simply because you can.
If you're prone to dipping into your savings account to pay for things other than what you're supposed to. I highly recommend keeping your savings account at a different bank than your checking account.
You'll mostly be seeing your checking account balance because that's where you'll make the most transactions and I don't want you to be tempted to easily transfer money to your checking account to pay your credit card bills.
Takeaway: Keep your savings account at a different bank than your checking account if necessary.
4. No Cards or Checks.
Most savings accounts don't provide cards or checks. You're typically only provided with cards and checks when you open a checking account.
If you tend to use checks, this might be a problem.
If you prefer to use checks and still want to have a savings account at a bank or other financial institution. You can open a Money Market Account (MMA) which provides a card and checks. An MMA is a type of savings account. More on different types of savings accounts below!
Takeaway: Most savings accounts don't provide a card or checks.
Why Open a Savings Account
You don't have to worry about your balance fluctuating in a savings account. You don't have to worry about potentially losing all of your money in a savings account.
Your savings account balance is guaranteed in an FDIC-insured bank. Just remember that there is a limit so if you have to, open accounts at different banks so that all of your money is insured.
It's important to open a savings account because you'll always need to keep a certain amount of money readily available.
As I've mentioned, a savings account is a great place to keep your emergency fund. An emergency fund is used to pay for the unexpected house, medical, or car bill. Your emergency fund is there to protect you from having to put a large expense on credit or have to take out a loan.
Most financial advisors recommend keeping 3-6 months' worth of living expenses in an emergency fund.
Wondering if you should have more than one savings account? Read, How Many Bank Accounts Should I Have, and you'll get your answer!
How to Open a Savings Account
Opening a savings account is quick and easy!
You'll only need a few things to open a savings account. You'll need a government-issued ID like a passport or driver's license, a social security number, and an address.
Before opening a savings account, make sure you take the time to do a little research. Open a savings account at a bank or other financial institution that will help you maximize your savings and keep your money safe.
Always remember to only open a savings account, and checking account for that matter, at an FDIC-insured bank.
How Much to Keep in a Savings Account
Your savings account purpose will depend on how much you need to keep in the account.
For example, an emergency fund savings account should total 3-6 months' worth of your living expenses.
If you plan on having an additional savings account, which I recommend you do for anything other than an emergency fund. How much you keep will depend on what you're saving for. Are you saving for a down payment on your first house, a new car, or your next vacation?
I'll say this one more time, I recommend having a savings account for just your emergency fund money. I wouldn't mix your emergency fund and vacation fund in the same account. It can become too easy to use money that's meant for an emergency to pay for things other than an emergency 😉
Types of Savings Accounts
1. Traditional and Regular Savings Accounts.
A traditional savings account is a regular savings account.
Traditional and regular savings accounts are available at brick-and-mortar banks or credit unions. You can also open an account online but it would still be with a brick-and-mortar bank. Banks like Chase, Bank of America, and Fifth Third Bank are examples of brick-and-mortar banks.
Traditional and regular savings accounts earn interest however, it's important to understand that when compared to other types of savings accounts, the interest rates are significantly lower.
As with most savings accounts, you're only allowed to make six withdrawals or transactions a month.
If you happen to make more than six withdrawals in a month, your financial institution will charge you a fee. During COVID, the withdrawal limit has been suspended so you're allowed to make more than six withdrawals a month without getting penalized.
2. High-yield Savings Accounts.
High-yield savings accounts are typically opened at online banks or credit unions because they offer the highest rates.
Similar to traditional savings accounts, you're only allowed to make six withdrawals or transactions a month.
When you begin searching for high-yield savings accounts, you'll notice that you'll see an Annual Percentage Yield (APY) versus an interest rate. The APY is a better indicator of your return versus looking at the interest rate. All you have to know is that the higher the APY, the better.
3. Money Market Accounts (MMAs).
Money Market Accounts (MMAs) are available at different financial institutions including online banks.
MMAs are sort of a hybrid between checking and saving accounts.
MMAs are similar to checking accounts given that if you wanted to, you could get a card and checks. Traditional and high-yield savings accounts don't provide either.
MMAs are similar to savings accounts given that the same withdrawal limits apply. you're only allowed to make six withdrawals or transactions a month.
MMA's offer higher interest rates than traditional savings accounts but lower interest rates than high-yield savings accounts.
4. Certificate of Deposits (CDs).
Certificate of Deposits (CDs) are available at brick-and-mortar banks, online banks, and credit unions.
The main difference between a CD and the above three savings accounts is that your money is "locked" for a predetermined amount of time.
You can't make any withdrawals during the predetermined time frame otherwise you'll get charged a penalty.
You choose the timeframe. For example, it could be 6 or 18 months before you can make a withdrawal from the account.
Also, CDs are different from other savings accounts given that interest rates are locked. Interest rates don't fluctuate (change) so you can actually calculate how much you'll earn in interest.