A savings account is a smart place to keep your emergency fund or any money you may want to use for short-term money goals, like a big upcoming purchase. The cash will be safe and somewhat accessible, but you won’t be earning much in interest. If you want your money to grow over time without the risk of investing, then a high-yield savings account can help.
These types of accounts offer a much higher annual percentage yield (APY) than standard savings accounts, so they’re a great option for those looking to earn a bit more on funds that are tucked away for later use.
What is a high-yield savings account and how does it work?
A high-yield savings account is a type of savings vehicle that you can open at many banks and credit unions. But it differs from a traditional savings account in that it offers an APY that’s 10 to 20 times higher than the national average.
Right now, the national average savings rate is 0.43%, according to the Federal Deposit Insurance Corporation (FDIC), while some of the best savings accounts offer rates at or above 5%.
Aside from the difference in interest rates, high-yield savings accounts work much like standard savings accounts. The bank may ask you to fill out an application and make a minimum cash deposit to open the account. Then the bank pays you interest, in the form of an APY, on the money you deposit.
While you can withdraw cash from any type of savings account, it’s best if you allow the money to remain in the account to grow over time.
“High-yield [savings] accounts are designed to encourage saving,” says Tara Alderete, the director of enterprise learning at Money Management International. “So there may be more restrictions on accessing your money, like no debit card or a limited number of withdrawals for example.”
The power of a high-yield savings account
Let’s say you open a standard savings account with an APY of 0.17%, and you make an initial deposit of $1,000. If you don’t make any other deposits for a full year, you earn $1.70 on your money.
Now let’s say another bank offers an APY of 2% that compounds daily. With the same deposit, you earn $20.20 after one year. While these are still relatively small earnings, your money can grow faster just by choosing a different savings account.
Best uses for a high-yield savings account
A high-yield account might be a good option for anyone looking to save money for a large purchase, a short-term or mid-range financial goal, or cash you want to keep safe, Alderete says. For instance, you might stash money in a high-yield account for:
- An emergency savings fund: With your emergency funds in a high-yield savings account, you’ll be able to access the money when you need it. And every extra dollar you earn with a higher APY can be helpful when paying for unexpected expected.
- Short-term financial goals: If you’re planning to take a vacation in three to six months or need to save up for a home repair, earning more in a high-yield savings account can be incredibly helpful in covering these costs. Also, keeping your savings in a dedicated account can make it easier to track your goal.
- A large purchase: Making a big down payment on a purchase like a car can help you lock in a more manageable interest rate. Any extra funds you can earn in a high-yield savings account can help with that—or even can be put toward your monthly payments.
Other savings vehicle options
There are many advantages to having a savings account—but it’s not great to keep all your money there.
“It’s likely not the best vehicle for a long-term savings goal like retirement,” Alderete says, because rates on savings accounts typically won’t beat the rate of inflation. For your long-term nest egg, a tax-advantaged retirement account or a regular brokerage account can offer more room for growth.
If you hit your short-term savings goal and have additional funds to spare, you might want to consider putting the money in a certificate of deposit (CD). A CD is a type of savings account that holds your money for a specific period of time (known as the term), ranging from a few months to a few years. In exchange, the issuing bank pays a fixed interest rate for the length of the term. Usually this interest rate is higher than what’s offered by high-yield savings accounts.
After you open a CD you can’t deposit additional funds to it—nor can you make any withdrawals. But the benefit of a CD over a high-yield savings account is that, “with a CD, you can lock in a specific interest rate and revisit the account once the term is over,” says Liz Ewing, the chief financial officer of Marcus by Goldman Sachs. “[Although] if you withdraw your money before the CD term ends, you could pay a penalty.”
What to consider when looking for a high-yield savings account
When shopping around for a high-yield savings account, here are some key factors to consider:
APY
The APY is a number that represents how much interest you can earn within a year on any money you deposit into the account. APY also compounds interest. This means you’ll earn interest on your current balance—including any additional interest you earned previously that year.
A higher APY is generally better because you’ll earn more, but you should weigh the APY against the requirements to earn the yield.
“Some banks will require you to open a checking account in addition to a high-yield savings account,” Ewing says. Some banks also require that you carry a certain balance to earn the APY, which we’ll cover later. You need to consider whether you can meet the balance minimum to earn the best yield.
Account fees
Some financial institutions charge fees such as monthly maintenance fees and minimum balance fees. “[Fees] can eat away at any earned interest,” Ewing says. You might be able to avoid these extra costs if you maintain a certain balance, but your best bet is looking for an account that doesn’t charge them at all.
Initial deposit
Check how much you’ll need to deposit to open the high-yield savings account. Some financial institutions let you open the account with no money and fund it later, which can be helpful if you’re just starting to earn and save money for the first time.
Minimum balance
Some banks and credit unions tie your interest rate to the amount of money in your account, typically rewarding a higher balance with a higher APY. Sometimes you’ll get hit with a fee if you don’t meet the minimum. Take the time to compare bank minimum balance requirements to make sure you can deposit enough money to earn the best APY and avoid any fees.
Compounding frequency
Your financial institution may compound interest daily, monthly, quarterly, or annually, depending on the bank and the account. “Accounts that compound more frequently will help you earn more,” Ewing says.
Deposit insurance
Wherever you decide to put your funds, make sure it’s either a bank insured by the Federal Deposit Insurance Corp. (FDIC) or a credit union insured by the National Credit Union Association (NCUA). These institutions provide coverage against bank failure of up to $250,000 per person, per account.
Withdrawal options
Some banks limit the number of withdrawals you can make from your account each month. Although the Fed did withdraw this rule during the pandemic, banks are allowed to continue imposing those limits.
It’s important to know your bank’s rules on withdrawals when comparing high-yield savings accounts.
Other financial offerings
Financial institutions that offer high-yield savings accounts may not offer many other services. For instance, they may not offer mortgages, credit cards, and personal loans. So before opening an account, consider whether it’s important to you that you do all your banking in one place.
Pros and cons of a high-yield savings account
A high-yield savings account offers a higher rate of return on your money compared to standard savings accounts. But some of these accounts charge fees, have minimum balances requirements, and offer variable interest rates that can go up and down over time.
It’s important to shop around and familiarize yourself with these pros and cons before opening an account.
Pros
- Higher interest rates
- Returns not tied to market fluctuations
- Insured against bank failure
- Interest compounds
- Easy access to funds
Cons
- Interest rates may change
- Withdrawal restrictions
- Potential fees
- Transfers between accounts may be delayed
- Inflation may erode earnings over time
What’s the difference between a high-yield savings account and a regular savings account?
The biggest difference between these accounts is that high-yield savings accounts offer rates that are 10 to 20 times the average savings rate.
You’ll usually find these high-yield accounts at online institutions rather than more traditional brick-and-mortar banks. To get the best rate, you might have to meet minimum balance requirements, make a minimum deposit, or deal with withdrawal limits. Regular savings accounts are readily available at both online and brick-and-mortar institutions, and they’re less likely to require a minimum balance or a minimum initial deposit.
The trade-off is that they offer lower interest rates.
The takeaway
Keeping your money in a high-yield account savings account is a small but important way to make sure your funds are safe, accessible, and can earn a strong interest rate. With those extra earnings you can make from your account’s APY, you can use them to help pay for everyday purchases or save toward other short- or long-term goals.
As you’re consider where to open your next account, you should consider the banks offerings, limitations, and whether it will support your money goals.
