Wednesday, February 8, 2012

Types of Savings Accounts

There are many different types of savings accounts available at banks and credit unions, and it may be difficult keeping track of the advantages and disadvantages of each type of account. Here is a quick rundown of the basics to each type of account:

Traditional Savings Account - A simple account available at just about any bank or credit union intended to hold money you set aside for any number of reasons. These accounts tends to have the fewest, if any, limitations on balances, very low minimum balances requirements, but also pay the lowest interest rates.

Money Market Account - Similar to the traditional savings account, except the interest rate is tied to the interest rates of money markets, which is a part of the financial markets for short term lending. These accounts have a slightly higher interest rate than traditional savings accounts, but tend to have higher minimum balances requirements (in the 1000s), and a low limit on maximum transfers per month (3-6 usually). There is sometimes a delay when transferring money out of the account. They are also offered at most banks and credit unions.

High Yield Savings Account - A savings account with a high interest rate that is usually a money market account, so it has all of the same limitations as a money market account. In addition, there is nearly always a delay when withdrawing money from this account when not using checks. A few banks and credit unions have these accounts, but they are now mostly available at online banks. Many people choose not to use a high yield savings account because the money is not immediately available.

Certificate of Deposit (CD) - A deposit you make at the bank where you agree to leave the deposit at the bank or credit union for specified amount of time, which is also known as a maturity date. Once the money has stayed at the bank to the maturity date you are paid interest on the money and allows to pull the money out. The longer you agree to leave the money in, the higher the interest rate paid to you. If you choose to pull the deposit out of the bank prior to the maturity date, then you forfeit the interest and pay an early withdrawal penalty. In the past CDs had interest rates that were noticeably higher than other types of savings accounts, but nowadays pay about the same interest rate. Unless you know that you will not need the money for a long time, CD's usually are not work the risk of early withdrawal penalties.

Health Savings Account (HSA) - A special savings account intended to hold money set aside for medical expenses available to people who have a high deductible health insurance plan. HSAs are tax advantaged in the sense that deposits to the account can be made pre-tax, and withdrawals are not taxed as long as they are used for approved medical expenses. HSAs tend to pay about the same interest rate of a money market account, and some banks allow the money can be invested. There is a federally mandated limit on the amount that can be contributed to HSAs annually. If money is pulled out for non medical expenses, than there is a penalty of 10% plus the owner will be charged tax on what is withdrawn.

Purpose of Savings Accounts 

Many people set aside money for different purposes, ranging for saving up for anything from upcoming expenses (short term savings), to expenses that are several years away (long term savings). However, the most recommended is an emergency fund. An emergency fund is just as the name implies - money set aside for times when there is a financial emergency. For example, common emergencies include a lost job, paying for car repairs or a car replacement when a car breaks down, severe damage to a house, or paying for a medical emergency. Some people also set up sinking funds, which is money set aside over time to pay for expenses that will happen but the time of the expense is unknown.

I have recommendations for how to split up your savings accounts, and why you should split up savings accounts, here.

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