What a savings account does with your money

A bank account that earns interest pays you a percentage of the money you keep in it. The bank lends your deposits to other customers, and shares a portion of what it makes back with you. The amount you earn depends on the interest rate the bank offers, how much you have in the account, and how long it sits there.

Interest compounds, meaning you earn money on the interest you've already earned. If you deposit $1,000 at 4% annual interest, after one year you'll have $1,040. In year two, you earn 4% on $1,040, not just the original $1,000. Over time, this compounds into real money—but only if you leave the balance alone.

The catch is that interest rates change. Banks raise and lower them based on what the Federal Reserve does and what other banks are offering. A rate that looks good today might be lower next month, or higher. You're not locked into a rate unless you open a certificate of deposit (CD), which holds your money for a set time in exchange for a may provide rate.

Key Takeaways

  • Interest rates vary by bank and account type, and change frequently based on market conditions and Federal Reserve decisions.
  • High-yield savings accounts typically pay more interest than regular savings accounts, but require you to keep money there without withdrawing it often.
  • Money market accounts and certificates of deposit (CDs) are other ways to earn interest, each with different rules about when you can access your money.
  • Your deposits are insured up to $250,000 per account type at FDIC-insured banks, so your principal is protected even if the bank fails.
  • Interest earned is taxable income, and banks will send you a 1099-INT form if you earn $10 or more in a year.

Types of accounts that pay interest

High-yield savings accounts are the most common choice for people who want to earn interest without locking their money away. They pay significantly more than regular savings accounts—currently ranging from 4% to 5.35% depending on the bank, though these rates fluctuate. You can withdraw money whenever you need it, though some banks limit you to six withdrawals per month before charging a fee.

Money market accounts work similarly to high-yield savings but often come with a debit card or checkbook, making them feel more like a checking account. Interest rates are usually slightly lower than high-yield savings, and minimum balances are often higher. They're useful if you want both interest earnings and easier access to your money.

Certificates of deposit (CDs) lock your money away for a set period—typically three months to five years—in exchange for a may provide interest rate. If you withdraw before the term ends, you pay a penalty, usually a few months' worth of interest. CDs currently pay between 4% and 5.5% depending on the length and the bank. They're useful if you know you won't need the money and want to lock in a rate.

Regular savings accounts at traditional banks typically pay less than 0.5% interest. They're useful mainly for emergency funds you need quick access to, not for building interest earnings.

How interest rates are set and what affects them

Banks set their own rates, but they're all responding to the same underlying force: the Federal Reserve's benchmark rate. When the Fed raises its rate, banks can pay more on deposits because they're earning more from loans. When the Fed cuts rates, banks lower what they pay you. This is why you'll see interest rates on savings accounts jump or drop over the course of a year.

Competition also matters. If one bank offers 5% on a high-yield savings account and another offers 4.5%, customers move their money. Banks that want to attract deposits raise their rates. Online banks tend to pay more than brick-and-mortar banks because they have lower overhead costs.

The type of account also affects the rate. CDs usually pay more than savings accounts because your money is locked away. Money market accounts pay less than high-yield savings because they offer more flexibility. Banks use these rate differences to encourage you to keep money in accounts where they can count on it staying put.

How to compare accounts and find the best rate

The first step is deciding what you need the money for. If it's an emergency fund you might need in three months, a high-yield savings account is the right choice. If it's money you won't touch for two years, a two-year CD will lock in a higher rate. If you want both interest and flexibility, a money market account splits the difference.

Once you know the account type, compare rates across banks. Online banks almost always pay more than traditional banks. Check the current rates at major online banks like Marcus, Ally, American Express Personal Savings, and Discover. Rates change weekly, so what you see today may be different next week. Some banks also offer promotional rates for new customers—higher rates for the first few months—so read the fine print.

Watch for minimum balance requirements. Some accounts require you to keep $2,500 or $10,000 in the account to earn the advertised rate. If you fall below that, the rate drops. Others have no minimum. Factor this into your decision if you're working with a small balance.

Check whether the bank is FDIC-insured. This means your deposits up to $250,000 are protected if the bank fails. All major banks are FDIC-insured, but verify before opening an account with a smaller or online bank.

What happens to your interest if rates drop

If you're in a high-yield savings account or money market account, your rate will drop when the bank lowers it. You won't lose the money you've already earned, but new interest will accrue at the lower rate. You can move your money to a different bank offering a better rate, though this takes a few days.

If you're in a CD, you're protected. Your rate is locked in for the entire term, no matter what happens in the market. This is the main advantage of CDs—certainty. The trade-off is that you can't access the money without paying a penalty.

If rates rise and you're in a savings account, you benefit only if your bank raises its rate. Some banks are slow to raise rates when the Fed moves. If your bank isn't keeping up, moving to a competitor is the fastest way to earn more.

Tax implications of interest earnings

Interest you earn is taxable income. The bank will send you a 1099-INT form in January if you earned $10 or more during the previous year. You report this on your tax return as ordinary income, taxed at your regular income tax rate.

If you earn interest in multiple accounts, the 1099-INT will show the total from all accounts at that bank. If you have accounts at different banks, each will send its own 1099-INT. Keep track of all of them when you file.

There's no way to avoid this tax—it's owed whether or not you receive the form. However, if you're in a low tax bracket, you may owe no federal tax on the interest even though it's reported. The form is informational; it doesn't determine what you owe.

Frequently Asked Questions

Can I lose money in a savings account that earns interest?

No. Your principal—the money you deposit—is protected by FDIC insurance up to $250,000 per account type at FDIC-insured banks. You earn interest on top of it. The only way to have less money than you started with is if you withdraw it or if fees exceed your interest earnings, which is rare in high-yield accounts.

What's the difference between a high-yield savings account and a regular savings account?

High-yield savings accounts pay 4% to 5.35% interest, while regular savings accounts at traditional banks pay less than 0.5%. The difference is usually because online banks have lower costs and can pass savings to customers. Both are equally safe if FDIC-insured.

Should I put all my money in a CD to lock in the current rate?

Only if you won't need the money before the CD matures. If you withdraw early, you pay a penalty—usually three to six months of interest. If rates rise significantly, you'll regret locking in a lower rate. Keep some money in a high-yield savings account for emergencies, and use CDs for money you're certain you won't touch.

How often does interest get added to my account?

Most banks compound interest daily and deposit it monthly. Some compound and deposit quarterly. The more frequently it compounds, the more you earn, though the difference is small. Check your account agreement to see how often your bank compounds.

What happens to my interest if I move my money to a different bank?

You keep all interest you've already earned. When you transfer money to a new bank, the old bank closes the account and you receive the full balance including all accrued interest. There's no penalty for moving money between savings accounts.