Opening a new account and closing an old one to move your savings might seem like a hassle, but that use of time can pay off.
After years of paying low interest rates to savers, banks in the United States are finally offering better rates on deposits. While the increases may seem small, compound interest compounds over the years, and you don’t want to miss this opportunity.
The Federal Reserve has raised interest rates in an attempt to mitigate inflation, in the face of which some banks have also improved terms for savers. Even if the savings in your bank account are modest, you could make more significant gains over the long term by finding an account with a better interest rate.
WHAT TYPES OF RATES ARE AVAILABLE?
While the largest national banks haven’t drastically changed their interest rates on savings accounts (they average just 0.23%, according to Bankrate), some mid-sized and smaller banks have implemented changes that are more in line with changes implemented by the Federal Reserve.
Online banks in particular – which reduce their expenses by not having physical branches and related fees – are offering savings accounts with annual percentage yields of 3% to 4%, or even higher, and 4% or more on one-year Certificates of Deposit (CDs). Some promotional rates can be as high as 5%.
WHAT SHOULD I KNOW ABOUT OPENING A NEW ACCOUNT?
Online banking has made it easy to move money around, so it’s fairly simple to keep your current account and, at the same time, open a high-yield account at another institution. Many have very low minimum balance requirements (as low as $1) so that you can transfer the minimum amount required to begin the process while keeping your primary checking account open.
WHY DON’T SOME PEOPLE MOVE THEIR MONEY INTO HIGH-YIELD SAVINGS ACCOUNTS?
According to Bankrate’s Sarah Foster, many Americans simply don’t know that high-yield savings accounts exist and the significant benefits available to them at today’s much higher rates. The average relationship between a consumer and their bank is 17 years, she commented, and reliance on the largest banks means they are “swimming in deposits” and don’t feel the need to offer better rates to attract customers.
Some people don’t know that most high-yield savings accounts are just as safe as those at traditional banks, he said, as long as they also have Federal Deposit Insurance Corporation (FDIC) deposit insurance for up to $250,000. You can check it out on the FDIC.gov website.
People are familiar with traditional banks and that can inspire a sense of security.
If you have a long-standing relationship with your current bank, you may feel comfortable there, and be aware of the rewards and advantages of that institution, such as no ATM or account management fees, cash back or other benefits. You’ve probably also set up direct deposits and automatic withdrawals for income, bill payments and other regular expenses.
However, opening a high-yield savings account doesn’t mean you have to switch all those automatic payments and transfers right away, according to Ken Tumin, founder of DepositAccounts.Com.
That can take time and energy, so you can slow it down, if you choose to do so. However, it could also be an opportunity to review your spending, cancel subscriptions you no longer want, automatic payments and services, or renegotiate recurring bills and expenses to the extent possible.
“Some people also say they don’t have accounts with an online bank because they’d rather have access to a local branch and the in-person services that includes,” Foster said.
WHAT DO THOSE INTEREST RATES ADD UP TO, IN REAL NUMBERS?
Let’s say you invest $500 in one of the five largest banks in the United States that offer an interest rate of 0.23%. After one year, if you don’t touch them or add anything to them, you will have earned $1.15. After five years, with compound interest, you will have earned $5.78. After 10 years, $11.62. And after 25 years, $29.56.
If you deposit the same $500 in a high-yield savings account with a 4% interest rate, then after one year you will have earned $20. After five, $108.33. After 10 years, $240.12. And after 25 years, $835.92.
With 1,000 dollars, the result is as follows: with 0.23% interest, after one year, 2.33 dollars. After five years, $11.55. After ten, $23.24. And after 25 years, $59.12.
With 4% interest: after one year, $40. After five, $216.65. After 10 years, $480.24. And after 25 years, $1,665.84.
In both cases, that assumes you don’t add anything to the account each year, but the best practice would be to make even small contributions from your paycheck, twice a week, once a month or a year.
To do your own calculations, including annual contributions and rate changes, you can use the Securities and Exchange Commission’s (SEC) compound interest calculator.
DO YOU PAY TAXES ON ACCRUED INTEREST?
Yes. Since you have already paid taxes on the balance of deposits in the High Yield Savings Account, you only pay additional taxes on the interest you receive each year. That interest is taxed at your earned income rate, so it is the same rate at which your income is taxed in that year.
CAN THE SAVINGS RATES ON THESE ACCOUNTS CHANGE?
Yes. Banks can promote a rate for these accounts and then adjust it based on other factors, such as changes in the Federal Reserve’s own rate. To avoid such changes, and ensure a guaranteed rate, you can choose a Certificate of Deposit, assuming you don’t need access to your money right away. Treasury instruments also offer competitive rates.
HOW DOES A CERTIFICATE OF DEPOSIT WORK?
A Certificate of Deposit pays a guaranteed rate for a fixed period, such as a month, a six-month, or a year. CDs can be purchased at most banks, and many have special offers. These rates are similar to those offered by high-yield savings accounts. However, penalties are imposed if you want to withdraw the money before the end of the chosen period.
WHAT ABOUT INVESTING IN GOVERNMENT BONDS?
The U.S. Treasury Department sells bills, notes, bonds, TIPS (Treasury Inflation-Protected Instruments) and savings bonds at TreasuryDirect.gov. All of these instruments are backed by the full faith and credit of the U.S. government, with varying rates depending on maturities. The minimum investment is $100, and some of the rates and yields on these investments are just as competitive and safe as the CDs and high-yield savings accounts mentioned above.
Currently, for example, a rate for Series I bonds – which are savings bonds designed to protect you from inflation – is 6.89%. With a Series I bond, you earn a fixed rate of interest and a rate that changes with inflation. Twice a year, the Treasury Department sets the inflation rate for the next six months. You can cash the bond at any time after 12 months, although you will lose certain portions of interest if you redeem it before five years.
HOW DO I COMPARE BANK RATES FOR DEPOSIT ACCOUNTS?
Reliable sites such as DepositAccounts.com, founded by Tumin, can help you compare rates and rank banks and accounts by rates and other factors. Other resources include Bankrate.com, NerdWallet and MyCreditUnion.gov.
Tumin says that, if you want to confirm that an online bank is FDIC-insured, you can visit FDIC.gov to search for it.
“In addition to finding the highest rate, it also makes sense to make sure these banks have a history of offering a competitive rate on that account over many years,” he added. “There are a lot of new banks that are offering high rates, but they haven’t been around very long. If they don’t have much history, they might not retain their competitiveness.”