Interest is how a savings account makes money for you
A savings account earns money through interest—a percentage of your balance that the bank pays you regularly, usually monthly or daily. The bank lends out the money you deposit to other customers and businesses, then shares a portion of what it earns with you. The more you have in the account and the higher the interest rate, the more you earn.
The rate you receive depends on the bank, the type of account, and the current economic environment. Banks change their rates frequently, so the rate you see today may not be the rate you get next month. Some accounts offer fixed rates that don't change for a set period; others offer variable rates that move with market conditions.
Key Takeaways
- Interest rates on savings accounts vary by bank and account type, and you should compare current rates before opening an account because small differences add up over time.
- High-yield savings accounts typically pay 4 to 5 percent annually, while traditional bank savings accounts often pay less than 1 percent.
- The amount you earn depends on your balance, how long the money stays in the account, and how often interest is compounded.
- Money market accounts and certificates of deposit (CDs) are alternatives that may pay higher rates but come with different rules about when you can withdraw.
How interest rates are quoted and what they mean
Banks advertise their rates as an Annual Percentage Yield (APY), which shows what you would earn in a year if you left the money untouched. A 4.5 percent APY means that if you had $10,000 in the account for a full year with no deposits or withdrawals, you would earn $450. The APY already includes the effect of compounding—interest earned on top of interest—so it's the most accurate way to compare accounts.
The actual amount you earn each month is smaller than the annual figure. On that same $10,000 at 4.5 percent APY, you would earn roughly $37.50 per month, though the exact amount depends on how the bank calculates and deposits interest. Some banks compound daily, which means you earn a tiny bit of interest on yesterday's interest; others compound monthly. Daily compounding adds slightly more to your total over time, but the difference is usually small.
Where to find the highest rates
Online banks and credit unions typically offer higher rates than traditional brick-and-mortar banks. Online banks have lower overhead costs and pass some of that savings to customers through better rates. As of early 2024, high-yield savings accounts at online banks were paying between 4 and 5 percent APY, while traditional bank savings accounts often paid less than 0.5 percent on the same balance.
Credit unions are member-owned institutions that sometimes pay higher rates than banks, though not always. You must be a member to open an account, which usually means living or working in a specific area or belonging to a particular organization. Checking current rates at a few different banks and credit unions takes 15 minutes and can mean hundreds of dollars in additional earnings over a year.
Rates change constantly, so a bank offering 4.75 percent today might drop to 4.25 percent next month. Set a reminder to check rates every few months, especially if you have a large balance. Some people move money between accounts when rates shift significantly, though this works best if you don't have withdrawal limits or fees.
Money market accounts and certificates of deposit as alternatives
A money market account is a hybrid between a savings account and a checking account. It typically pays a higher interest rate than a regular savings account but may require a larger opening balance—sometimes $2,500 or more. Money market accounts usually come with a debit card or checkbook, so you can access your money more easily than with a traditional savings account, though there are still limits on how many withdrawals you can make per month.
A certificate of deposit (CD) is an account where you agree to leave your money untouched for a set period—three months, six months, one year, or longer. In exchange, the bank pays you a higher rate than a savings account. If you withdraw the money before the term ends, you pay a penalty, usually a few months' worth of interest. CDs work well if you know you won't need the money for a specific amount of time and want a may provide rate that won't change.
How compounding affects your earnings over time
Compounding means you earn interest on the interest you've already earned. If you deposit $5,000 at 4.5 percent APY and never touch it, after one year you have $5,225. In year two, you earn 4.5 percent on $5,225, not just the original $5,000, so you earn about $235 instead of $225. The longer the money sits, the more noticeable this effect becomes.
Over 10 years, that same $5,000 at 4.5 percent APY grows to about $7,795 without any additional deposits. If you add $100 per month, it grows to roughly $16,500. The difference between a 4.5 percent account and a 0.5 percent account over 10 years is thousands of dollars, which is why comparing rates before you open an account matters.
Fees and minimum balances that reduce your earnings
Some savings accounts charge monthly maintenance fees, which directly reduce the interest you earn. A $5 monthly fee on a $1,000 balance earning 4.5 percent APY means you're paying $60 per year to earn roughly $45 in interest—a net loss. Always check the fee schedule before opening an account, and look for accounts with no monthly fees.
Minimum balance requirements also affect your earnings. If an account requires you to maintain $2,500 and you only have $1,000, the bank may charge a fee, close the account, or pay you no interest at all. Some high-yield accounts have no minimum balance; others require $25,000 or more. If you have a small balance, choose an account with no minimum or a minimum you can comfortably meet.
What to do if your bank's rate drops
When a bank lowers its rate, your earnings drop automatically. You don't have to do anything—the lower rate just applies to your next interest payment. If your bank's rate falls significantly below what other banks are offering, you have the option to move your money. There's no penalty for closing a savings account and opening one elsewhere, though it takes a few days for the transfer to complete.
Before moving money, confirm that the new bank's rate is genuinely higher and that you understand any minimum balance requirements or fees. Also check whether the new bank's rate is likely to stay competitive or if it's a promotional rate that will drop after a few months. Reading the account terms or calling the bank directly can answer this question.
Frequently Asked Questions
Is the interest I earn on a savings account taxable?
Yes. Interest earned on a savings account is considered income and must be reported on your federal tax return. Banks send you a 1099-INT form each January if you earned $10 or more in interest during the previous year. The amount you owe in taxes depends on your overall income and tax bracket.
Can I lose money in a savings account?
No. Savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per account holder per bank. This means even if the bank fails, your money is protected. Credit union accounts are insured by the National Credit Union Administration (NCUA) with the same $250,000 limit.
How often is interest deposited into my account?
Most banks deposit interest monthly, though some deposit it daily or quarterly. The frequency doesn't change how much you earn in a year—the APY accounts for all compounding—but daily deposits mean you start earning interest on that interest sooner. Check your account terms to see when your bank deposits interest.
What's the difference between APY and APR?
APY (Annual Percentage Yield) includes the effect of compounding and is what banks use for savings accounts. APR (Annual Percentage Rate) does not include compounding and is used for loans and credit cards. For savings accounts, always look at the APY, not the APR.
Should I move my money if another bank offers a slightly higher rate?
If the difference is small—say, 0.25 percent—and you have a modest balance, the extra earnings may not justify the effort of moving. But if you have $50,000 or more and the difference is 0.5 percent or higher, moving could earn you hundreds of dollars per year. Calculate the difference and decide whether it's worth the time to transfer.