Personal financial management demands one to have an understanding of the available bank accounts and the variation in what they provide. Another question that various customers want to know is, “Why do savings accounts pay more interest than checking accounts?”
The answer is quite apparent: savings accounts typically offer more interest than checking accounts. So why is that, and what does it mean in terms of your strategic financial planning? We outline the breakdown of features between a savings and checking account, how it amounts to the rates, and — more significantly — the methods you can employ to earn more cash.
Table of Contents
Understanding Savings Accounts vs. Checking Accounts
What Is a Savings Account?
A savings account is a deposit account that earns interest to the saver that is held at a bank or a building society. Its primary goal is to enable you to reserve cash for near-term goals but keep it accessible when you need it. So, if you are looking to create an emergency cushion, save for an object like the purchase of a house, or invest in something without losing too much of an ‘investment.’ In that case, a savings account is ideal for you.
Key features of savings accounts:
- Interest Earning: When you compare checking accounts vs. savings accounts, it has been stated that checking accounts have lower interest rates than savings accounts.
- Withdrawals Are Limited: Federal regulations limit the number of certain types of withdrawals to six a month.
- Safety: Savings accounts are insured by FDIC or NCUA, meaning they will cover you for up to $250,000 in the event of any loss.
What Is a Checking Account?
A checking account is an account that people use for day-to-day activities — paying bills, buying goods, or withdrawing cash. While savings accounts are more difficult to access, checking accounts are more readily accessed, which is why they usually get little to no interest.
Key features of checking accounts:
- It’s Convenient: Checking accounts offer users debit cards, checks, and online banking.
- Unlimited Transactions: There is no limit on any withdrawals or deposits.
- No Interest or Very Low Interest: Checking accounts typically earn minimal interest, if any.
Why Do Savings Accounts Offer More Interest Than Checking Accounts?
One of the reasons interest rates on savings accounts are higher than on checking accounts is because of how the Federal Reserve views them. Banks use the money deposited and make loans that earn interest, which is why savings accounts offer higher interest. In exchange, the savers receive a portion of that amount from the bank, also known as interest.
However, checking accounts are supposed to be liquid and used many times. Because the deposits in checking accounts are not retained with the bank for long periods, there’s a limited amount of money that’s available to invest in order to produce earnings. That’s why, in most cases, checking accounts don’t earn much interest or none at all.
How Much More Interest Can You Earn?
The precise range of the differential interest rates on savings with that of a checking account will depend on each bank and the market. As of 2024, the average interest rate for services accounts such as checking and single deposit accounts is expected to range from about 0.01% to around 0.50%, while high-yielding savings accounts could pay rates from 4.5% to about 5.5%.
The latter is one of the rare checking accounts that truly earn interest (the other 0.01%). For a case in point, if a trade-in point keeps a savings ledger at an elevated interest rate, be it $10,000, it will pay $500 at the arrival of the following year if APY on the shared fund is 5%. This interest, in case there was a checking account paying a 0.01% APY, would have earned a mere $1.
Pros and Cons of Savings Accounts
Pros
- High-Interest Returns: Make more profit from your funds alongside checking accounts as well.
- Funding Guarantee: Your funds are guaranteed by the United States government up to a certain amount of $250,000.
- Accessing Cash: Withdraw or transfer the sum that you need when you prefer, with some limitations.
Cons
- Withdrawal Limits: June of 2016 saw stricture of certain withdrawals to six in a month, courtesy of federal guidelines.
- Lower Returns Than Other Investments: Inflation pertains to depreciation, and savings accounts are hardly able to come close to the value presented by the dollar or returns from stock or bonds
- Minimum Balance Requirements: It is also normal for some accounts to require a minimum balance to avoid penalties and obtain the highest rates.
Tips to Maximize Your Savings Account Earnings
- High-Yield Savings Accounts: It is often the case that a bank and a union that operates over the Internet pay a higher rate of interest on their account than a traditional physical bank.
- No fees: It is critical to avoid accounts with monthly maintenance costs or even minimum balances.
- Savings on autopilot: You can also schedule transfers from your checking to your savings account in order to grow your savings balance over time.
- Do Compare: Seek a rate that is from more than a single institution because it is highly possible to find one that meets your requirements.
When to Use a Savings Account vs. a Checking Account?
- Use a Savings Account For:
- Building an emergency fund.
- Saving for short-term goals (e.g., vacations, weddings).
- Earning interest on idle cash.
- Use a Checking Account For:
- Daily transactions (e.g., paying bills, shopping).
- Managing monthly expenses.
- Accessing cash via ATMs or debit cards.
Frequently Asked Questions (FAQs)
1. Can I use a savings account for everyday transactions?
While the money can be taken out of a savings account, it is essential to note that federal regulations limit the rate of withdrawals to six per month. When it comes to day-to-day transactions, a checking account is far better suited.
2. Are savings accounts safe?
Definitely, savings accounts are safe. It depends on which of these three banks covers the funds: defined insurance coverage of FDIC or NCUA against credit unions for each account holder of each institution of up to $250,000 insurance.
3. What’s the difference between a savings account and a money market account?
Money market accounts, on the other hand, tend to have higher minimum balances but come with higher earnings than savings accounts and may include check-writing access.
4. How do I open a savings account?
You can open a savings account at a bank branch or online. You need to provide a few details, like your name, address, social security number, and how much you need to open the account.
5. Can I have both a savings and a checking account?
Those accounts are indeed standard with a number of people. People generally use checking accounts for everyday transactions, while a savings account is used primarily to save and receive interest.
The Bottom Line
Due to the relatively higher interest rate they pay than checking accounts, savings accounts are ideal components for growing your funds while at the same time keeping access to them. By knowing the distinctions between these accounts, one can select which account best fits one’s requirements, making the best out of one’s finances. Be it a rainy day or a specific goal, a savings account allows one to reach their targets while getting decent interest rates on the amounts deposited.
Don’t forget to check rates, stay fee-free, and set up an automatic savings payment to get the most out of your account. Once everything is set up correctly, your savings account will become an asset rather than a liability.
