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Savings Accounts: Everything You Need to Know

February 26, 202118 minute read

Understand Savings Accounts

Whether or not you feel like your current earnings warrant it, there are a lot of good reasons to consider opening a savings account.

For instance, it’s far more secure than stashing bills under your mattress (or anywhere else, for that matter). Not only does it keep your earnings safe from potential calamities like fire, flood or theft, savings accounts are also insured by the federal government for up to $250,000.

Additionally, putting money away for a rainy day makes long-term goals more achievable. Buying a home or car may feel daunting, but meeting such goals becomes far easier if you have a plan. Short-term goals — like travel, buying holiday gifts or even home improvements — also become achievable when you work toward them step-by-step.

Life happens, and it’s a good idea to set money aside to deal with random events like car or home repairs, moving costs or travel to visit a sick relative. A savings account helps you avoid unnecessary debt when there’s an emergency. Plus, saving up several months of household expenses can reduce some of the pressure if there’s a loss of income due to, say, a global pandemic.

Finally, you have the potential to earn money as you save. When you deposit money into a savings account, your bank or credit union usually pays interest in return.

So, how much should you save? A common budgeting method is the 50-30-20 rule, which recommends that you spend 50% of income on needs, 30% on wants and 20% on savings or debts.

Examples of needs are housing, groceries, utilities (such as electricity, gas and water) and transportation. Wants are items of personal desire or entertainment, such as clothing, hobbies, eating out or club memberships. Debts are everything from credit cards to student loans to car payments.

If you need a little help distinguishing what you spend on these categories, try this: On the first day of the month, begin asking for a receipt for everything you purchase. At the end of the month, separate the receipts into wants, needs, and savings or debts.

In terms of choosing a savings account, you have many options. Understanding the types of savings accounts available and the ways they earn interest can further increase your savings.

High-yield savings are accounts that require a large initial deposit, have a higher interest rate and allow limited access to funds.

Certificates of deposit, or CDs, are intended to hold a fixed amount of money for a fixed period of time. While these accounts usually offer higher interest rates than traditional savings accounts, your money must remain in the account, and withdrawing funds from a CD before the fixed period ends (typically six months, one year or five years) may result in a penalty.

Money market accounts are offered by banks and credit unions. They require a minimum initial deposit, and you typically have to maintain a minimum balance and are allowed a limited number of monthly transactions. These accounts usually offer lower interest rates than CDs, but the cash is more accessible.

Money market funds are available through investment companies. They generally provide higher returns than interest-bearing bank accounts, but returns aren’t guaranteed or insured by the government.

A bond is a debt investment. When you purchase a bond, you are lending money to someone else (known as the issuer). In exchange, the bond issuer pays back the original amount (known as face value) as well as interest for a specific period.

As you decide which way to go, look for accounts with few or no fees (such as minimum balance, maintenance or transaction fees). Fees add up and may chip away at your savings balance on a monthly or annual basis.

Whichever type of account you settle on, when you invest your money in savings, you’ll be sure to rest more easily — not only from the fewer lumps in your mattress, but from knowing your money is safe and working for you.

Building Emergency Savings

As much as we’d like to avoid thinking about them, emergencies do happen. That’s why building an emergency savings account dedicated to handling the unexpected is so important.

But it can be hard enough to handle regular expenses like rent and utilities, much less save money for an emergency. Preparing for the unexpected cost of repairing a car or home appliance, falling ill, or losing a job may fall through the gaps in your monthly budget.

The standard advice is to reserve three to six months of living expenses for emergencies. While this may sound intimidating, it’s important to remember that saving is a process.

If you can’t save a lot, it can be hard to find the motivation to save at all. But saving anything you can (even small amounts) is helpful. You don’t need to set aside a huge sum of money all at once. Even $100 is a great start.

Saving is easiest when you plan for it. Then take small steps toward your goal. Figure out your needs. Track your income and expenses. Then set a realistic overall goal. Decide on a minimum monthly amount to put away. Make a habit of saving, and limit your spending. Remember that any progress is good progress, even if meeting your goal could take months or years.

One way to speed up the process is to use a high-interest savings account, which will let you earn a little extra money along the way. Credit unions and online banks typically offer higher yields than brick-and-mortar banks. But be sure to compare your options: Your funds should be easily accessible, not subject to fees, and have the highest available interest rate (currently 1% for savings accounts). You could even open a savings at a different financial institution than your checking account so you won’t be as tempted to dip into it.

There are a number of methods for making those monthly contributions less painful. If you have a regular employer with direct deposit, you can divert a designated amount of your paycheck into your savings account each pay period. There are also savings-focused apps that let you round up any card-based transactions and deposit the difference into your savings account.

Finally, if you’re lucky enough to be owed a tax refund, give your emergency funds a boost by earmarking a substantial part (if not all) of that surplus income for savings.

It may take months (or years) to build an emergency savings fund, so don’t worry if progress seems slow. Keep at it! Sooner or later, you’ll hit your goal. And you’ll be sure to benefit from what you’ve saved when the unexpected happens.

Let's consider certificates of deposit

If you’re looking for a low-risk savings option for a fixed period of time, a certificate of deposit, or CD, may be the right choice for you. CDs are a type of savings account designed to hold a fixed amount of money for a fixed period of time, with guaranteed returns. Along with being low risk, they typically offer higher interest rates than standard savings accounts.

Like savings accounts, CDs are federally insured up to $250,000, so they’re safe as well as stable. Still, there’s a lot to consider when deciding whether a CD is the right savings option for you. Some key points to keep in mind:

  • Your funds are fixed. While typical savings accounts allow you to deposit and withdraw money, CDs require a fixed amount of money at the time you open the account, after which you generally can’t make further deposits. And if you need to withdraw funds before the CD matures, you may have to pay a penalty.
  • Your term is fixed. While you can select the period of time for your CD to mature — such as six months, one year or five years — you’re then locked into that time frame. The tradeoff? In most cases, the longer the term, the higher the interest rate.
  • Aside from any penalties you might be charged for early withdrawal, there’s a risk that, over time, inflation may be stronger than your interest gains, which would lower the value of your CD.
  • When the CD matures, you’ll have a short grace period (usually 5-10 days) to withdraw your money before the original term and rate are automatically renewed.

There are a number of benefits to CDs, however, that may outweigh the inconveniences:

  • CDs typically offer a higher interest rate than a regular savings account. And since the rate is fixed, this makes each CD low risk and highly predictable.

Since you know the amount of money in the account, the interest rate and the period of time that your funds will remain in the CD, you can accurately estimate how much interest you’ll earn as well as the date you’ll receive your interest and original deposit back. This is advantageous for financial planning.

The best type of CD to get depends on your situation. While all CDs share certain characteristics, there are a variety of types to consider.

Traditional CDs typically have low deposit minimums and fixed interest that may be compounded daily or annually. At the end of the term you can withdraw your money or roll it over for another term.

Jumbo CDs typically require a minimum deposit of $100,000 and offer higher interest rates.

Liquid CDs, also known as no-penalty CDs, offer the option to withdraw money before the maturity date without a penalty, but typically have lower interest rates than traditional CDs.

Brokered CDs are offered by brokerage firms and independent salespeople. Individuals known as deposit brokers may be able to negotiate higher interest rates on CDs, but these are typically more complex and carry more risk. Deposit brokers do not have to be licensed or certified, so consider conducting a thorough background check on the issuer or deposit broker.

Before deciding if a CD is right for you, take the time to consider whether the restrictions involved will allow you to meet your financial goals.

Talk to your financial institution to learn about the specific CD options available to you. Then start saving!

Using Health Savings Accounts

We’d all like to save money on medical expenses, but for anyone enrolled in a high-deductible healthcare plan (HDHP) those expenses can be burdensome. That’s why a health savings account (HSA) might be just what the doctor ordered.

In case you’re unfamiliar with them, HDHPs are government-defined plans that offer a lower insurance premium but a higher deductible. They tend to favor either younger, healthier enrollees who don’t expect regular or expensive medical procedures or people with larger incomes who are better equipped to pay the increased deductibles.

Using an HSA can make the bulk of these healthcare expenses more manageable. This comes by way of a triple tax benefit: tax-deductible contributions, tax-free earned interest or investment gains and tax-free withdrawals for qualified medical expenses.

Among the downsides of using an HSA is that you can only contribute to one if you’re already enrolled in an HDHP — which means that a high deductible is a fact of life.

You can enroll in an HSA either on your own or through an employer. If it’s through your employer, then the easiest way to meet your savings goals is to make pretax contributions through regular payroll deductions. You, a relative or anyone else can also make direct contributions, as long as you don’t exceed that year’s government-mandated limit. The funds in your account are then available for any qualified medical expenses, accessible with a debit card or check.

The money in your HSA is yours to keep for life, even if you switch employers, healthcare plans or retire. At the end of each year, any unused funds will continue to roll over for life. In other words, unlike a flexible spending account (FSA), the funds in your HSA aren’t “use it or lose it.”

Another benefit of HSAs is that they earn interest — a minimal amount, usually — but it can add up over time. Some accounts allow you to increase your returns by investing your savings into stocks, mutual funds or other securities (although, like any such investment, this can be risky, and consulting with a financial adviser is recommended). The best part is, any earned interest or investment gains are tax free.

One other advantage: If you end up not using your HSA funds for medical expenses, you can save the money for retirement. As long as you’re 65 years or older, you’re allowed to withdraw funds for nonmedical expenses. You may still need to pay income tax upon withdrawal, but likely without additional penalties.

There’s always the risk that, if you’re short on emergency savings, any unplanned, nonmedical expenses can strain funds and impact your ability to make regular contributions to your HSA.

Additionally, some HSA providers charge fees or transactions, such as ATM withdrawal fees or account closures. Withdrawing funds for non-healthcare-related reasons can also result in penalties — up to 20% of the costs — if you’re under 65, and the withdrawal is taxable.

In order to make the most of your HSA, it’s important to contribute an amount that’s right for you. That can mean contributing the maximum annual amount, aiming to cover only the cost of your deductible or saving as much as you think you’ll need for medical expenses in a particular year.

Whatever your goal, having a tax-free source of funds to pay your medical bills is a great way to offset the burden of a high deductible — from now until after you retire.

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