How does a high yield savings account work?

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Whether you’re saving money for an unexpected emergency or a dream vacation, a high-yield savings account is a great way to build your savings over time.

Most people who save money in a traditional savings account don’t currently earn much, if any, interest. In fact, according to the Federal Deposit Insurance Corporation (FDIC), the average savings account offered a return of just 0.07% as of May 2022.

For someone with $10,000 in a savings account for a full year, earning that meager rate of interest over the course of 12 months would yield only $7 of growth. Five years from now, that growth rate would still only yield about $35 if no other money was deposited into the account.

For this reason, high-yield savings accounts are instead one of the best places to store your short-term savings. You get the same protection and account security as a traditional savings account, but you can earn 10x the national average on your balance.

Here’s what you need to know about how these high yield accounts work and why you might want to consider one for your short-term savings:

Understand high yield savings accounts

High yield savings accounts work very much like any type of traditional savings account. The biggest difference between a high yield account and a traditional savings account is the interest rate, or APY, that you can earn on your balance.

Many high-yield accounts are offered by online banks or online divisions of brick-and-mortar banks, and often don’t have physical branches. Because they can save on the costs associated with maintaining a branch, online financial institutions can offer higher returns (and often better terms) on their savings accounts and other financial products.

In fact, online banks’ savings account rates are often 10x or higher than the national average. Many of the banks that offer the best interest rates on high yield savings accounts today have even higher interest rates, some even exceeding 1% APY.

There aren’t many downsides to choosing a high-yield savings account with an online bank over a traditional savings account, says financial advisor Jeff Rose of Good Financial Cents. As with traditional institutions, your savings at an online bank can be insured for up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). And with many online accounts, you can waive minimum balances or monthly fees.

However, Rose points out that you may have less access to personal support when you need it. Make sure you can easily manage your account and mostly transfer money online or via a mobile app before choosing an online bank.

Average interest rates for high yield savings accounts

In general, high-yield savings accounts offer much higher interest rates than the national average. However, the interest rates offered by banks can fluctuate very frequently. That’s because banks often base the interest they pay (and the interest they charge on loans and credit cards) on the Federal Funds Rate set by the Federal Reserve.

The Fed started raising rates earlier this year to fight inflation and is expected to continue to do so for the next few months. As a result, banks will continue to increase the APYs they pay on savings accounts to keep up with their competition. Many experts believe this will ultimately lead to savings account rates exceeding 2% by the end of 2022.

Right now, the accounts on our list of the best savings account rates have an average APR of 0.96%.

How Much Can You Put Into a High Yield Savings Account?

Like a regular savings account, a high yield account typically has no limit on the amount of money you can deposit. However, there may be some limits associated with your account that you should be aware of.

Some high yield accounts may have caps on interest income. These caps are typically very high ($500,000 to $1 million) but should still be noted in your account terms and conditions.

Others may lower your APY after you reach a certain balance. That’s one reason to be cautious before signing up for a high-yield savings account, which has a much higher APY than similar account types.

Some of the highest advertised interest rates have maximum deposit limits, says Robert Farrington, millennial money expert and founder of The College Investor. For example, you might say that you can earn 4% on your balance, but only up to $5,000.

“After that, the rate goes down,” says Farrington. “You want to make sure that the account you choose offers not only the best rate, but also the best rate for the balance you’re about to deposit.”

Another balance limit to consider is the amount up to which your account is insured. Before opening a new savings account, you should make sure the account is insured by the FDIC or the National Credit Union Administration (NCUA). These institutions protect up to $250,000. If your account has FDIC coverage, this insurance is per depositor, per FDIC-insured bank for each property category. For credit union accounts insured by the NCUA, credit union members can only receive up to this amount of coverage across all of their joint accounts combined.

Are High Yield Accounts Riskier?

High-yield savings accounts with online banks are a safe place to keep your money. And choosing an account with FDIC or NCUA protection can keep your funds insured in the event of a bank closure or other issue with the institution.

High-yield savings accounts are also protected from market fluctuations that can affect riskier investment accounts. Although index funds or mutual funds can generate a potentially higher return over the long term, they are more susceptible to short-term market changes.

As such, high-yield savings accounts are best suited for short-term savings or emergency funds that you may need to access on a short-term basis. However, for long-term investing and retirement planning, it’s smart to diversify with an investment account like a Roth IRA.

Who Offers High Yield Savings Accounts?

You’re most likely to find competitive, high-yield savings accounts at online banks. However, some banks that offer generous returns on savings products have a few brick-and-mortar locations. Often these are online divisions of a more traditional bank.

Examples of online banks that offer exceptional returns on their banking products are Barclays, CIT Bank, Marcus by Goldman Sachs and Ally. Capital One is a good example of a mix of the two – its Performance 360 ​​savings are available online, but it’s also a large national bank with physical branches you can visit.

How to choose and open a high-yield savings account

Before opening an online savings account, make sure it is insured by either the FDIC or the NCUA. From there, you should compare savings accounts based on the interest rates offered.

“The higher the interest rate, the more your money grows,” says Rose.

pro tip

Watch out for online savings accounts that offer exceptionally high interest rates but have deposit limit restrictions. For example, some advertise up to 4% APY, but only on the first $5,000 you deposit. If you have a lot more in your savings account, you might be better off with a slightly lower APY with no maximum.

There are also other features that can help you narrow down your choices. For example, if accessibility is important to you, look for a bank that allows you to withdraw money from ATMs. Or if you prefer to use your phone to make changes and transfers to your account, make sure the bank you choose has a robust mobile app and not just online browser access.

“Jumping through hoops to withdraw money for a financial emergency is the last problem you want to deal with,” says Rose.

Other things to look out for are monthly fees, whether the account has a minimum deposit requirement, or whether you need to hold a certain balance in order to earn interest or keep the account open.

Luckily, opening a high-yield savings account is easy once you find the one you want. All you have to do is select the option to open an account online and provide personal information such as your name, address, social security number and additional contact information. From there, you can fund your online savings account by transferring money from another bank account.

bottom line

Ultimately, there are many great high-yield savings accounts out there today that can help you earn a great APY without charging hidden fees or costly minimum fees. The most important thing is to just start saving. Choose an account with the features and APY that works for you, and make it a habit to top up your balance regularly.

You may also want to set up direct deposits into your account each month so you can contribute passively. Even if you can only save a few dollars at a time, your total balance can add up quickly.

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