What is a savings account? For most people, those are traditional savings accounts, the kinds you can get at a local bank or credit union, that pay interest while you accumulate funds.
In truth however, there are many different savings plans, and you can use several in combination to meet your savings goals.
There are a number of savings vehicles available to help you to save money. Each works in its own particular way, and can fill a specific savings need.
There are of course basic savings accounts, which are the simplest. But there are several other accounts that may work better for you. Most likely, you’ll used several different savings plans at any given time.
Let’s look at the most common savings vehicles available.
The Different Types of Savings Accounts
Traditional Savings Accounts
Traditional savings accounts are the most basic savings accounts. They’re interest-bearing accounts that while highly liquid, are designed primarily as an accumulation account for some specific spending purpose. This is unlike a checking account, which you will access regularly to pay bills and other expenses.
In fact, savings accounts are specifically limited in the number of withdrawals you’re allowed to make from the account. Under federal Regulation D, you’re only permitted six withdrawals per month. If you exceed that number, the bank will charge an excess withdrawal fee. And most banks will convert the account to a checking account if you exceed that limit too often.
In today’s low interest rate environment, local banks and credit unions typically pay interest of only a fraction of 1% on savings accounts. Still, traditional savings accounts are an excellent way to save money for short-term purposes, particularly in emergency fund.
High Yield Online Savings Accounts
Fortunately, there are different types of savings accounts. In the previous section, we discussed the types of traditional savings accounts that are available at local banks and credit unions. But those are hardly your only option. An increasing number of online banks are offering high-yield savings accounts that pay rates many times higher than local banks.
According to the Federal Deposit Insurance Corporation (FDIC), interest rate averages on various savings products were as follows as of March 4, 2019:
These are rates paid primarily by local banks and credit unions. But there are number of online banks where you can get much higher rates.
For example, WebBank currently pays 2.35% APY on savings accounts with a minimum balance of $1,000. CIT Bank is currently paying 2.45% APY on its Savings Builder Account. You generally need a minimum balance of $25,000 to get that rate, but you’ll also qualify with monthly deposits of $100.
Money Market Accounts
Money market accounts are something of a hybrid between savings accounts and checking accounts. Like savings accounts, they pay interest on your deposits, and usually at a somewhat higher rate.
But the main difference between the two accounts is access to your funds. Money market accounts usually come with check writing privileges or an ATM card, and sometimes both. These will allow you to access your account directly. By contrast, savings accounts often limit access to transfers into your checking account where the money can be spent as needed.
An example of a money market account paying high interest is UFB Direct. They’re currently paying 2.45% APY on their Premium Money Market Account. This is much higher then the money market rates you’ll get at a typical local bank or credit union.
Individual vs. Joint Savings Vehicles
These refer to the ownership/access aspect of savings accounts. An individual account is owned by one person, who has the exclusive right to access funds from the account. A joint account has two or more owners, and each has access to the funds in the account.
But the difference between the two account types is more than cosmetic. Since FDIC insurance provides protection of deposits of up to $250,000 per depositor, an individual account will be limited to just $250,000 in coverage. However, a joint account with two owners will be covered for up to $500,000.
Certificates of Deposit (CDs)
Certificates of deposit are a higher interest alternative to savings accounts. CDs are sometimes referred to as time deposits because they require you to tie up your money for a specific amount of time.
CD terms can run anywhere from 30 days to 10 years. In most cases, the longer the term of the CD, the higher the interest rate paid on it.
CDs work best when you have a longer-term savings goal that’s expected to be needed within a certain very specific time frame. For example, if you’re planning on saving for the down payment on a house in five years, you can invest your money and five year CDs. The money will be completely safe, and will pay interest throughout the term.
Once again, interest rates paid on CDs by local banks and credit unions tend to be on the low side. But CDs offered by certain online banks pay much higher rates.
Each of the following online banks are currently paying 3.10% on a five year CDs, and rates close to that for much shorter term certificates:
One thing to be aware of with CDs is early withdrawal penalties. They apply to most CDs at most banks. Typically, if you withdraw funds from a CD, or liquidate the entire certificate early, you’ll pay a penalty equal to a certain percentage of the interest you’ve received. For example, on CDs with a term of 12 months or longer, the penalty might be equal to three month’s interest.
Prepayment penalties vary from one bank to another, and from one CD term to another. If you invest in CDs, you’ll need to know what the prepayment penalties are for each certificate.
Savings Plans for Minors and Students
Children under the age of 18 are legally prohibited from opening bank accounts. However, a parent or guardian can establish a guardianship account under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). The funds in the account belong to the minor, but are managed by the parent or guardian as trustee.
The account can be held as a checking or savings account, money market account, CD, or even a brokerage account.
Funds can be added to the account, but can only be withdrawn for purposes related to care of the minor. When the minor reaches the age of majority in their state, the account transfers over to the minor, and the parent or guardian no longer acts as trustee.
But there are also college savings plans that can help you accumulate funds for your children’s future education.
The most popular is the 529 plan. Contributions to a 529 plan are not tax-deductible, but the investments held in the plan build on a tax-free basis. The funds can continue to build up until they are withdrawn.
Once they’re withdrawn, they can be taken tax-free, as long as they’re used to pay for qualified higher education expenses. These include basic tuition, fees, books, room and board, and any computer equipment or software required as part of the course of study.
There are no specific limits to how much you can contribute to a 529 plan, but most people set a limit of $15,000 per year. That’s the annual limit at which the federal gift tax is triggered, though there are ways to contribute higher amounts.
Health Savings Accounts (HSAs)
HSAs are savings plans with a very specific purpose, and that’s paying for healthcare related expenses. Most typically, the funds in the account are used to pay for copayments, deductibles, and coinsurance provisions that exist and most health insurance policies. However, payment of health insurance premiums is specifically prohibited.
Though an HSA can be held in different types of accounts, it’s most usually a special savings account, that comes with both a debit card and check writing privileges. Contributions to the plan are tax-deductible, and interest and other investment income can accumulate on a tax-free basis.
You’re limited to withdrawing funds from the account for approved medical expenses only. However, the account can build up over many years, all the way to age 65, at which point it can become something of a medical IRA.
Contribution limits are $3,500 for an individual and $7,000 for a family. There’s an additional “catch-up” contribution of $1,000 for participants 50 and older.
To participate you have to have a health insurance plan that’s considered a “high deductible health plan” (HDHP), defined as a minimum deductible of $1,350 for an individual or $2,700 for a family. But there’s also a maximum out-of-pocket limit of $6,750 for an individual and $13,500 for a family. All numbers above are for 2019.
Employer Sponsored Retirement Plans
Retirement savings plans are an important alternative to savings accounts. That’s because they function as the longest term savings plans in your portfolio. While other types of savings plans cover short and medium-term goals, retirement plans are for much later in life.
If you have a retirement plan offered through work, you should absolutely participate in it. There are various plans, including the 401(k), 403(b), 457, and thrift savings plan (for federal workers). Each enables you to contribute up to $19,000 for 2019, plus an additional $6,000 if you’re 50 or older.
There are several benefits to participating in a plan:
- As noted above, the contribution limits are substantial.
- Your contributions are tax deductible, meaning the government is making part of the contribution.
- Investment income accumulates on a tax-deferred basis, which means you can invest and grow your money with no tax consequences.
- Funds are taxable only when withdrawn, which should be at a lower tax rate in retirement.
- Many employers offer a matching contribution, which is like getting free money.
Individual Retirement Accounts (IRAs)
If you don’t have a retirement plan offered by your employer, you can always set up your own individual retirement account. You can do this with a bank or brokerage firm, depending upon your own investment preferences. You can contribute up to $6,000 per year, or $7,000 if you’re 50 or older.
There are two types of IRAs, traditional and Roth.
Traditional IRAs. Your contributions to this plan are tax deductible, and your investment income accumulates on a tax-deferred basis. Funds withdrawn at retirement are taxable at ordinary income tax rates. But when you retire, you’ll probably be in a lower tax bracket.
If you withdraw funds from a traditional IRA before reaching age 59 1/2, they’ll be subject to ordinary income tax, plus a 10% early withdrawal penalty.
Roth IRAs. These are basically the same as a traditional IRAs, except for the tax consequences. Contributions to a Roth IRA are not tax-deductible. But like a traditional IRA, investment earnings on your account are tax-deferred. But you can begin withdrawing funds from the account on a tax-free basis beginning at age 59 1/2, and as long as you’ve been in the plan for at least five years.
One other advantage of the Roth IRA is that you can withdraw your contributions before retirement, without having to pay either ordinary income tax or an early withdrawal penalty. This will give you access to the funds if they’re needed sometime between now and retirement.
Just be aware that any amount withdrawn from a Roth IRA that exceeds your contributions will be subject to ordinary income tax and the 10% early withdrawal penalty.
How to Choose the Right Savings Vehicles for You
As you can see, there are several different savings plans, and each fills a very specific need. If you’re searching for the right savings vehicles, try using this formula to pick the right one:
- Short-term savings goals or an emergency fund. Favor traditional savings accounts or money market accounts at local banks or credit unions, or high-yield online savings accounts for higher returns. You’ll earn interest, and your money will be completely safe.
- Medium term savings goals. If you’re saving money for a new car, the down payment on a house, starting a new business, or even saving for a vacation, CDs are your best bet. You can match the term of the CD with the expected date of the expense. With CDs, you can earn even higher interest, and your money will be completely safe.
- Savings for minors. Set up a guardianship account with a local or online bank under the UGMA or UTMA. The funds will belong to the minor, but you’ll be able to access them for the minor’s benefit.
- Saving for college. 529 plans are the best bet for this purpose, since you can contribute a large amount of money to a plan, and the investments accumulate on a tax-free basis.
- Retirement. Go with an employer-sponsored retirement plan, like a 401(k) or 403(b) plan. But if you don’t have one through work, open either a traditional or Roth IRA at a bank or broker.
What’s fortunate is that there are savings plans you can match with virtually any expected future financial need. Use the above list as a guide, and look into the savings vehicles in this article.