There are benefits and disadvantages with most kinds of savings accounts
Getty ImagesAlthough inflation in the US pulled back slightly last month to 8.3% after seven months of incessant gains, it remains uncomfortably high not just in the US, but in the UK and other countries, with one COO calling the situation a “perfect storm.”
The eye of the storm surfaced due to the COVID-19 pandemic, and now, we are seeing the ripple effect this economic disease has had on the financial world.
The stock market is in disarray, the Great Resignation (and so-called Great Reshuffle) is underway, and closer to home, we feel the sting of rising food and energy prices, with a general surge in the cost of living.
Inflation is a reduction in purchasing power over a period of time, caused by factors including the rising prices of goods or services. This can also be caused when there is a notable increase in the money supply.
For example, if you used to pay $100 a month for electricity and now you must pay $200 a month every 12 months, this increase in the price of the service may reduce your purchasing power elsewhere — think going out to eat, buying a new car or booking vacations — and this, in turn, impacts demand for other goods and services, potentially hampering economic growth.
While the price of everyday goods, like milk and gas, can be individually inflated, inflation looks at the broader picture and a general rise in prices across the board. Inflation remains in the stratosphere: In March, the US Consumer Price Index (CPI) reached 8.5%, a rate not seen since 1981, and economists have warned that inflation could pass 10% in the UK.
Earlier today, however, the US Department of Labor announced the CPI retreated to 8.3%, ending a 40-year high. Although today’s announcement is a welcome news, 8.3% is still a hefty weight on households and there’s still no end in sight. In fact core prices — excluding food and energy categories — rose 0.6% from March to April.
As everyday expenses increase, consumers may also feel the squeeze on their savings — and their rate of return.
Should you open a savings account?
The general rule is that if inflation is higher than the interest rate of your savings account, in real-world “purchasing power” terms, you are losing money as the intrinsic value of each currency “unit” is going down, not up.
But if you’re trying to tighten your belt in the face of high living costs and want to make sure you have some money stashed away to weather the storm, the question to ask yourself is: Should I open a savings account?
There are benefits and disadvantages with most kinds of savings accounts. Despite the US Federal Reserve recently raising interest rates by 50 basis points (or half a percentage point) rates are pretty poor across the sector (at least, for now). However, savings accounts are still worth considering as a safety net. Here’s how to get started.
Terms to learn
Terms you should become familiar with
- Inflation: Generally, the rising cost of living/consumer services and goods over a sustained period.
- Consumer Price Index (CPI): The CPI measures changes in the prices consumers pay, and inflation is calculated based on these figures.
- APY: The annual percentage yield, or interest rate, offered by a financial service or account.
- Transaction, service fee: Some banks and financial providers will charge account opening fees, service charges, or a fee every time you make a transaction — and this can include making one-off payments or setting up direct debits.
What do you want your savings account for?
The first question to consider is what you want the savings account for. Do you want an account separate from your standard checking account to save a few dollars as and when you can, or for an emergency fund? Or, do you want something long-term?
There are many different types of savings accounts on the market, including:
- Traditional savings accounts: Opened at your bank, easy access, and an interest rate between 0.01% and 1.00%
- High-yield savings accounts: Higher interest rates (up to 1.25%) but may impose service fees and withdrawal limits, as well as minimum balances
- Retirement funds: Funds either saved or invested on your behalf and typically locked in until retirement age. These can include IRA/Roth IRAs (US) and UK personal pensions (SIPPs).
- Online-only savings accounts: Only managed online and may not accept cash, but typically offer better APY rates due to lower overheads
- Certificate of deposit (CD) accounts (US): Banks and credit unions may offer CD accounts at high, fixed interest rates (up to 2.00%). However, there is usually a minimum deposit to earn interest, and funds are held over a fixed term, such as 12 months or five years. You are earning more interest, but you can’t withdraw your cash without a penalty before the term ends on its “maturity” date.
- Money Market accounts (MMAs) (US): A money market account is similar to a high-yield savings account but may give you a debit card and checkbook. Minimum balances to earn high APY (up 0.82%) may apply.
- Accounts for children: Many savings accounts will require an adult as a custodian or joint owner. For example, the Capital One Kids saving account is in the child’s name, offers up to 0.30% APY, and is managed by a guardian.
When you’re making your choice, keep in mind that regular savings accounts can provide you quick access to your funds in the case of an emergency, whereas some types of accounts — such as retirement or cash-to-investment products — can lock in funds for years.
“It’s worth noting that most regular savings accounts are linked to current accounts, meaning you can only open one if you already have or open a bank account with that bank or building society,” commented Connor Campbell, personal finance expert at NerdWallet. “Therefore, it may be worth seeing which current accounts are on offer, too. Some regular savings accounts, however, are open to all and you can usually apply online. By checking both current accounts and the linked savings accounts, you might end up with a more holistic improvement to your personal banking than just by opening a savings account alone.”
What are the interest rates like?
At a high of 1.25%, high-yield savings accounts can’t beat rising inflation, but they can buffer the impact. When you’re looking for a new savings account, whether to open or to switch, you’ll want to find the highest interest rate possible.
The average savings account in the US is currently reported at 0.06% APY — and when you compare this to the surge in inflation, it’s poor.
However, some banks are offering online-only savings accounts with APY rates beyond the national average. The best rate we’ve found so far offers 0.61% APY.
Now the federal reserve has increased its benchmark interest rate by half a percentage point to try and combat inflation, we may begin to see more competitiveness in the market — especially as some financial organizations are offering far beyond the average rate.
Do savings accounts have fees?
Banks or other financial service providers may impose fees to open a new account, switch, or close a savings account. Savings account providers may impose fees when processing transactions (a common practice when making international payments), when ATM withdrawals are made, or through maintenance fees/service charges.
There may also be withdrawal limit fees if a consumer makes too many withdrawals or transfers during a specific time period.
However, many financial organizations will waive monthly maintenance fees if there are regular deposits or the savings account always maintains a specific balance.
Here are some examples:
- US Bank: Savings account maintenance fees of between $4 and $10. Fees may be waived if the account is opened for someone under the age of 18 or if a minimum amount is held in the account.
- Chase: Chase Savings has a monthly fee of up to $5 (which can be waived) or up to $25 for premium accounts. Chase may also charge between $2.50 to $5 for making withdrawals from a non-Chase ATM.
- Citi: Citi Bank’s Basic or Access savings accounts have a $4.50 monthly fee unless an average monthly balance of $500 is maintained.
- Bank of America: Bank of America’s Advantage savings account has no monthly fee as long as a balance of $500 is maintained, you are a student, under 18, or there are waivers due to you already being a client. However, withdrawal fees of $10 are charged when there are more than six withdrawals/transfers in a month.
Are there any requirements to open a savings account?
When choosing your savings account, you should also know of potential requirements or restrictions. These may include:
- Age: Some accounts will only be available after you’ve turned 18. Other savings accounts can be opened for minors, with restrictions, or by an adult on behalf of a child.
- Opening balance: You may be required to deposit a minimum amount to open a new account. For example, US Bank savings accounts require a deposit of between $25 and $100, depending on the type of account you want.
- Daily balances: Some accounts can only be signed up for on the understanding there will be a minimum amount held. For example, the Chase Savings account may require a daily balance of $300 or more if other terms are not met.
- Credit score: You may also need a specific credit score rating to open a savings account. Banks may perform a soft check for pre-approval or a hard check before opening an account for you, although if you’re already a customer, you might bypass this process. Generally, credit scores from fair to excellent are most likely to be accepted.
Read on: What is my credit score? Why it exists and why you need to build it
Does the savings account have any perks attached?
Perks may include overdraft protection if a savings account is linked to a checking account, cashback offers, higher interest rates when a set balance is maintained, or “clubs” that give you discounts on partner items and services. For example, Club Lloyds offers free magazine subscriptions, movie rentals, and cinema tickets.
Most US banks will offer premium savings accounts with higher monthly fees in return for perks. For example, the Wells Fargo Platinum Savings account offers unlimited withdrawals and a higher interest rate.
Is the savings account protected by governing bodies?
You should check if your bank is insured by the Federal Deposit Insurance Corporation (FDIC) in the United States. The deposit limit covered by the agency is usually $250,000 and includes checking accounts, typical savings accounts, MMAs and CD savings accounts. Although, the rules are different depending on the asset category, such as for trusts.
The FDIC does not generally cover investment products.
In the UK, the Financial Services Compensation Scheme (FSCS) covers bank accounts holding up to £85,000, or £170,000 in joint accounts if an approved bank or financial institution goes bust.
Most major financial products are protected, but you should always check if there is FDIC/FSCS cover if you are investigating a lesser-known savings account.
Do I have to pay tax on savings account interest?
In short, yes. Even if APY rates are paltry at best right now, you still have to declare any interest you receive on your savings. This includes your checking accounts, savings accounts, CDs, bonds and money market accounts.
Are stocks, shares — or even crypto — alternatives to savings accounts?
You can open “savings” accounts which are based on stocks and shares investments. For example, a stocks and shares ISA removes some tax liability while converting funds into investments.
You can turn to these products instead of a traditional savings account, and choosing long-term investments in stable index funds, for example, can provide you with an annual return on investment closer to, or beyond, the CPI. This may potentially preserve the real-time value of your money more than today’s interest-based accounts, but they also come with a level of risk.
It can also be challenging to pull your money out on short notice.
“One way to battle against inflation is to put your cash into a stocks and shares ISA, where returns are linked to the performance of the stock market instead,” commented Laura Howard, Editor at Forbes Advisor. “But while, historically, stock market-based investments have produced much better returns than cash savings accounts, you’ll pay the price in that your cash is always at risk — this means you could get less out than you put in. There’s also a spectrum of costs to consider, such as an annual management fee and trading charges.”
When it comes to cryptocurrency as a savings option, while the returns can be lucrative, any form of investment in virtual assets comes with very high levels of risk. The volatile nature of the market means you shouldn’t put anything in that you can’t afford to lose, so we can’t recommend this as a savings option.
Whether or not you also choose to explore other options, if possible, you should always have an emergency fund that can be easily accessed.
“Ultimately, where you keep your cash — if indeed there is any surplus after meeting the rising cost of household bills and other essentials — will come down to factors beyond just returns,” added Howard. “For example, how readily you will need access to your money, what other accounts you already have, and whether you would be able and willing to take a hit on your capital.”
What are our top picks for savings accounts?
ZDNet keeps up with the market trends and has compiled a list of our top picks for US consumers looking for a new savings account.
At the moment, our top pick is Ally’s High Yield Savings account, with an APY of 0.50% and low fees.
Read on: The 5 best savings accounts: Earn while you save
The information presented by ZDNet is not intended to be individual investment advice and is not tailored to your personal financial situation. It does not constitute legal, accounting, or tax advice, nor a recommendation to buy, sell or hold any investment. We encourage you to discuss investment options with your financial adviser prior to making any investments.
