How does a savings account work to store and grow your money?

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In a Nutshell

A savings account can be a safe place to store your money. And thanks to interest, your savings can even earn you some money.
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A savings account is a place to store and grow your money.

But how does a savings account work? These deposit accounts offer benefits for you and for the financial institutions you use. Learn more about what savings accounts offer in terms of security for storing and growing your money, and how your cash works to help keep banks in business.



How savings accounts work

When you deposit money into a savings account with a bank, credit union or other financial institution, it uses your funds to earn revenue. Your bank typically makes money on your savings account by lending the cash to other customers for auto loans, home mortgages, personal loans, student loans and more. Customers who borrow from the bank pay interest in exchange for the money, creating income for the bank.

While the money in your savings account may earn money for the bank, it’s also earning money for you. With savings accounts, you can store your cash separately from the day-to-day spending in your checking account. You can open and fund a savings account with cash, a check or a direct deposit from another bank.

Federal law has strict cash reserves rules aimed at helping banks stay in business, so you generally can’t make more than six withdrawals per month from a savings account. This includes automatic withdrawals, online transfers, payments by debit card and more. Less-convenient modes of withdrawal, such as in-person or ATM transactions, won’t count toward that limit. While the Federal Reserve paused this rule in 2020 amid the COVID-19 pandemic, it may reappear as the economy recovers.

Despite the withdrawal rules, a savings account can still benefit you and your financial institution. Banks provide an accessible and generally secure place to keep your money, but there are trade-offs: You won’t earn as much interest as you might with other types of accounts.

How compound interest works on a savings account

When you open a savings account, you may earn one of two types of interest: simple interest or compound interest.

For bank accounts with simple interest, the interest rate only applies to money deposited in your savings account, known as your principal.

Compound interest, on the other hand, applies the interest rate to the total amount you have in your account — both your principal and any interest you’ve already earned. A savings account with compound interest works harder, earning interest on interest, and typically grows faster.

Here’s an example of compound interest in action: Let’s say you open a savings account with $10,000. You don’t make any more deposits or withdrawals, and the account earns 0.5% interest compounded every month.

After five years you’d have about $10,253. Here’s how your earnings break down year by year.

Year 1: $10,050.11

Year 2: $10,100.48

Year 3: $10,151.10

Year 4: $10,201.97

Year 5: $10,253.10

In this example, you’d earn 0.5% interest on your current principal and interest every month, boosting your total savings over time. Of course, adding more deposits or getting a higher interest rate would allow your money to grow even faster.

Unfortunately, brick-and-mortar banks may not offer the most competitive savings account interest rates. With many financial institutions offering low interest rates, consider looking for better rates elsewhere, like a high-yield savings account from an online bank.

How FDIC insurance protects a savings account

When you’re shopping for a savings account, you’ll want to know your deposits have protection from a worst-case scenario like the bank going out of business.

Backed by the U.S. government, FDIC deposit insurance — from the Federal Deposit Insurance Corporation — offers protection for your money if the bank fails. Bank failure isn’t likely, but the FDIC would pay for your insured balance up to a certain amount within a few days of the bank closing, if necessary. You can find out if your bank is FDIC-insured using the FDIC’s BankFind tool.

When you bank with FDIC-insured financial institutions, you don’t have to sign up for deposit insurance. You’ll receive automatic coverage for your savings account’s principal and accrued interest, up to $250,000 per ownership category in each FDIC-insured bank where you have an account.

But you won’t have FDIC deposit insurance for all types of products, even if they came from an FDIC-insured bank. Investments like stocks, bonds, mutual funds and annuities could lose value based on the market and won’t have FDIC deposit insurance.

Are savings accounts at credit unions FDIC insured?

The FDIC doesn’t insure deposits at credit unions. But the National Credit Union Administration, an independent federal agency that oversees credit unions, provides up to $250,000 of federal insurance to account holders at most credit unions.

How much it costs to have a savings account

It’s tricky to compare the cost of savings accounts. While most banks will require $25 to $100 to open and fund the account, there may be additional expenses you aren’t expecting.

You might have to pay a monthly maintenance fee if your savings account doesn’t meet specific rules, like keeping a minimum balance. Luckily, there are free savings account options, regardless of your balance, like Credit Karma Money™ Save.

Here are some other typical savings account expenses.

  • Minimum balance fees — Your bank may charge a fee if your balance dips too low.
  • Overdraft fees — Banks may charge fees for overdrawing your account. If you’ve linked your savings account to your checking account for overdraft protection, it’s possible you could overdraw your savings.
  • ATM fees — If your bank doesn’t have physical branches, it could be costly to access money from other banks’ ATMs. Some banks are willing to reimburse you for ATM fees, though.

As you search for the best savings account, consider perks that some banks offer, like cash bonuses for banking with them. Before opening any account, make sure to read the fine print.

How to use your savings account

While there are clear benefits of opening a savings account — building an emergency fund, saving for your goals and earning interest, and keeping your money somewhere that offers more security than your piggy bank — you should also consider the disadvantages before signing up.

One is that, if you already have an emergency fund and still have money to save, your money might earn a higher return in other types of savings vehicles like a certificate of deposit.

You’ll also want to know about any savings account fees and how to avoid them. Otherwise, you could rack up fees that could slash your earnings.

Another drawback is the monthly withdrawal limit, which may be a hassle if you need more frequent access to the funds.

If the pros outweigh the cons, and you’re ready to open an account, you’ll usually need two forms of identification, like your driver’s license and a utility bill. You’ll also typically need at least $25 to $100 to fund the account.

To maximize your savings account and grow your balance, rely on the power of automation. You can’t spend money if you don’t have access to it. Try setting up recurring transfers from your checking account or paychecks into your savings account. With less money in your checking account, you may be less tempted to overspend. Before you know it, you’ll be one step closer to reaching your other savings goals.


What’s next?

You can find savings accounts through traditional banks, online banks, credit unions or fintech companies. While traditional banks and credit unions offer in-person service, you may find a higher annual percentage yield through online banks or fintech companies.

But before picking the account with the highest APY, there are other factors you’ll want to consider. Look for account restrictions, cash accessibility, hidden fees, minimum balances and deposit insurance. And you may also compare the company’s technology and customer service reputation. While it may be tough to find a savings account that checks the boxes, some research will bring you closer to the best possible fit.


About the author: Kate Dore is a Nashville-based personal finance writer and Candidate for CERTIFIED FINANCIAL PLANNER™ Certification. She teaches financial literacy with Junior Achievement and writes for Business Insider, Investopedia… Read more.