Savings Accounts Guide

1. What are Savings Accounts?

Back in the old days, lots of people parked their money in traditional savings accounts because the options were more limited. But now there are all sorts of financial products that act as piggy banks for your funds.

There are old-fashioned savings accounts at brick and mortar banks, which for reasons we outline in the next section, aren't a smart place for your money. They give such measly interest on the money, if they pay any interest at all, you're almost as well off sticking those funds under your mattress.

Some banks offer special senior and student savings accounts that offer moderately higher interest rates and waive fees and balance minimums that can pinch your money. They are basically traditional savings accounts with better deals.

There also are IRAs , money-market funds , and CDs -all of which tend to provide higher returns but place greater restrictions on when and how you can access your funds.

Fortunately, high-yield savings accounts -also known as online savings accounts because many of them originated on the web-have developed as a better alternative for increasing your assets.

These accounts were popularized in 2002 when ING, a unit of a large Dutch financial services company, started offering an online savings account called the Orange Savings Account. ING didn't have any bank branches, and it still doesn't. In return for opening the account up online and doing all of the transfers via the web, customers could get rates up to 10 times greater than what local banks offered. By doing away with overhead like tellers and rent, ING could afford the more attractive rates.

With the recent volatility in the stock market, high-yield savings accounts have taken on an added shine. Other online banks have started copying ING and even more familiar names like Citibank are competing to offer more rewarding interest rates for online accounts. These accounts have become good places to accomplish all sorts of financial goals, such as maintaining an emergency fund or saving toward a major purchase.

High-yield savings accounts are pretty easy to open-you don't have to go anywhere or talk to anyone. That doesn't mean it's quick. Most banks have you sign up online and electronically link your new high-yield savings account to your normal checking account, which you have with another bank. It can take several days for the online savings bank to make sure the two-way link is working.

Once that's done, however, you can generally link as many accounts as you want to your new high-yield savings account. You can link your checking account, a brokerage account-whatever. Moving money around isn't instantaneous, but transfers usually go through in a couple of business days.

You can usually fund your account with just a dollar; most high yield savings accounts don't have minimum-balance requirements.

Like a normal checking account or any bank account, the money you deposit in an online savings account is insured for up to $100,000 (or $200,000 if it's a joint account with a spouse) in case the bank goes under. The government provides this insurance through the Federal Deposit Insurance Corporation (FDIC).

One tax note: The IRS counts the interest gains from online savings accounts as "ordinary income." That means you pay the same tax rate on it that you would for money earned from a job. You don't get to pay the lower capital gains tax rate, like you would on money made from selling a stock that's appreciated over a period of time, usually two years.

2. Should You Open a Savings Account?

A penny saved is a penny earned. This adage suggests the benefits of thriftiness and putting away your money for the future. But it's also an apt description of the returns you're likely to see from a traditional savings account at a brick-and-mortar bank. With their low interest rates, that's how you'll be able to count your earnings-in pennies.

With so many investment options, it makes almost no sense to sock away your money in a regular old savings account, where it draws little interest. In fact, the one of the only reasons people tend to stick with a low-yield account is due to an extremely stubborn or lazy nature.

You'll be much better off opening a high-yield savings account.

These accounts can be beneficial for several reasons. They are a great place to hold money that you're worried you might need soon or know you will need soon. Many people like to have an emergency fund with a few months worth of salary saved in case they lose their job or an unexpected expense arises. No reason to keep that money in a checking account that pays well under 1% in interest, though. And there are usually no restrictions on when you can access your funds, unlike CDs and IRAs that assess penalties for early withdrawals.

The same rationale goes for a vacation fund or money you'll need for a down payment in a year or two. If you're saving the money anyway, you might as well make some extra interest on top of it. See how much of a difference a few points can make using our savings account interest rate calculator.

Similarly, high-yield accounts can help you reach your savings goals, particularly if you are not the most disciplined hoarder. Many banks offer direct deposit and automatic savings plans that allow you to set aside a specified amount each month. This can help you save when you know you might not otherwise.

Finally, high-yield accounts are a safe investment, especially if you are nervous about the financial markets. For one, they are FDIC insured, so you have no risk of losing your money. And they can offer steady if not spectacular returns.

3. Advice for Getting the Best Deal on a Savings Account

With so many online savings account banks now in the mix, it pays to hunt for the best deal out there. Start by scouring the bank's web site for information and read its FAQs carefully. Then, shop around for the best rate. There are many online rate comparison tools, like ours.

But don't go bonkers looking for the absolute best rate. Unless you're stashing a huge wad of cash, a quarter or half percentage point is not likely to contribute much to your bottom line. Remember that the difference of 0.25% is only worth $25 per year on a $10,000 deposit.

That said, we're not big fans of ING's popular Orange Savings Account. ING consistently offers rates that are one-half to one percentage point worse than its most generous competitors. Why? They're betting that people will invest with ING because it's the market leader and many people have heard of the company. While it hasn't built branches, its spent oodles on marketing, ING also knows that many people don't shop around, so the bank feels like it can get away with not offering a truly great deal. If you're savvy, you can find more favorable options.

A few more general caveats:

Watch out for introductory rates

Banks may try to lure you in with fantastic introductory rates, only to drop them after the first three months. This isn't necessarily a drawback, just be aware that your rate may eventually fall-which is fine as long as it remains competitive. You should also know that the interest rates that banks pay on high-yield savings accounts aren't fixed for the life of your account. They'll fluctuate along with economic and competitive conditions.

Stay away from inexperienced banks

Steer clear of banks without a long history in online savings accounts. They often struggle as money flows in and the bank gets used to running these sorts of accounts online. It's best not to let them practice on you, so go with a bank that's been offering these accounts for at least six months. On a related note, try to gauge the bank's customer service operations. Since many won't have a branch near you-or any at all-you want to make sure they'll be responsive to your questions and concerns.

Know the account rules

You may be drawn in by a killer interest rate, but don't be blinded by it. Some banks will try to sneak in restrictions like minimum balances or require you to open a companion checking account to secure the best rate. Or there could be unnecessary fees for exceeding your transaction limit or closing your account. You want an account with few strings attached.

4. Grilling Guide: Questions to Ask Banks About High-Yield Savings Accounts

Do you require a minimum balance to open a savings account? And are there any fees for not maintaining a minimum balance?
Most banks don't require minimum balances, so you may want to look elsewhere if they do. Of course, if you have a lot of money to squirrel away, this might be irrelevant.

Do you charge monthly service fees?
We don't know of any banks that do this, but it's worth asking just in case. Lots of checking accounts have these fees.

Are there fees for closing an account?
These are particularly obnoxious. Why should you have to pay a fee if the bank hasn't been able to keep your business? Still, they're out there-brokerage firms, in fact, often charge administrative fees to cover the cost of moving all of your account information to the broker you're switching to.

Do you base interest rates on how much money I keep with you?
We don't necessarily begrudge banks that want to treat their biggest customers better. Fortunately, not every bank does this. If you only have a small pile of money, don't work with a bank that has different rates for people with different amounts of savings.

Can I link to any other external account that I want?
A good financial institution will not place any limits here.

Can I transfer money in and out as much as I want, or am I limited to a certain number of transactions each month? Are there fees for transferring money or doing so frequently?

Some banks may limit you to five or six transfers a month. This may not be a problem for many people, but if you plan to move money around all the time to maximize the interest you earn, then pay careful attention. For regular transfers, you shouldn't pay any fees-and a frequent transfer fee should be small.

Is there ATM access?
It's nice to be able get the money fast in a pinch. Then again, with such free access, it can be easy to spend money you intend to hoard.

Do you offer direct deposit?
Your paycheck is likely your biggest source of income. Why not stash it in an online savings account and move only enough money to a checking account to cover your monthly bills?