There's a benefit to putting money into a savings account. Savings accounts are very flexible, allowing you to access your funds whenever you need to. Also, your principal deposits are protected as long as they don't exceed $250,000 and your bank is FDIC insured. For a joint account, this limit rises to $500,000.
But savings accounts also aren't perfect, and there are a couple of drawbacks to using one. Here are some pitfalls you might encounter with a savings account -- and how to get around them.
Downside No. 1: Your interest rate isn't set in stone
You might put money into a savings account at a time when its APY is 4.00%. But in four months from now, your account's APY could fall to 3.50%, which means you're then earning less interest on your money.
Solution: Open a CD instead
CD rates are set in stone. When you open a CD, you're guaranteed the interest rate you sign up at for the duration of your CD's term.
The Federal Reserve is expected to cut interest rates at some point in 2024. Once that happens, the APY on your savings account is likely to drop. You can avoid losing out on interest income by putting your money into a CD. You may, in fact, want to lock in a longer-term CD -- say, one with a term of 48 or 60 months -- in anticipation of rates falling over the next few years, which may happen given how elevated they are today.
Downside No. 2: Your interest income will result in a tax bill
The interest income you earn in a savings account is taxed as ordinary income, which means it's taxed at the highest rate you're subject to based on your marginal tax bracket. If you earn a lot of interest in a savings account this year, you may end up with a smaller tax refund in 2025. You might even have to write the IRS a check.
Solution: Put money into a Roth IRA and invest it
If you're saving your money for retirement purposes, opening a Roth IRA is a great way to get out of paying taxes on your gains related to that money -- in the near term and the long term. Roth IRAs allow you to invest your money in a tax-free manner. You can contribute up to $7,000 this year if you're under 50, or $8,000 if you're 50 or older. Roth IRAs have a variety of investment options, including CDs and bonds.
Let's say you put $5,000 into a Roth IRA this year and it eventually becomes worth $20,000 over time. You won't have to pay taxes on that $15,000 gain -- ever.
Savings accounts are convenient. And they're the absolute best place for your emergency fund. But if you prefer a savings option with a guaranteed interest rate, a CD could be a better bet. And if you don't like the idea of having to share your profits with the IRS, then you may want to look at a Roth IRA instead.
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FAQs
Cons: Low Yield
Safety and liquidity in savings accounts come at a steep price: traditional savings accounts offer a paltry amount of interest compared to other types of accounts. They are one of the least rewarding ways to save money, earning interest rates between 1 percent and 2 percent per year.
What are the downsides of a savings account? ›
Cons of Savings Accounts
- Interest Rates Can Vary. Interest rates for both traditional and high-yield savings accounts can vary along with the federal funds rate, the benchmark interest rate set by the Federal Reserve. ...
- May Have Minimum Balance Requirements. ...
- May Charge Fees. ...
- Interest Is Taxable.
There are several benefits to having a traditional savings account—fewer fees, lower minimum balance requirements, and interest on your savings, to name a few.
What are the advantages and disadvantages of saving money? ›
Saving has many benefits such as providing a financial safety net for unexpected events, liquidity for purchases and other short-term goals, and being safe from loss. However, there are also some drawbacks to consider, such as missing out on potential higher returns from riskier investments.
What are 2 disadvantages of traditional banks? ›
Disadvantages:
- Lower accessibility (more strict KYC/AML requirements). ...
- Inability to do business with some countries;
- Potentially outdated online banking;
- Longer time needed to open accounts;
- Banking must take place during business hours;
- Potentially higher monthly fees;
- Clients have to deal with a lot of bureaucracy.
Cons of brick-and-mortar banks
- They charge higher fees and often have high minimum balance requirements.
- Loans and other products may cost more.
- They typically pay lower yields on savings and other deposit products.
- Visiting a branch takes longer than banking online.
means that you want to be able to earn as much interest as possible while still liquidity, safety, and convenience. One advantage of a regular savings account is that it has high liquidity, meaning that you can get your money out easier. One disadvantage of a regular savings account is that it has low interest rates.
Is it good or bad to have a savings account? ›
Saving money can help you deal with financial emergencies that come up down the line. It can also help you avoid debt, pay for large purchases, reduce financial stress and provide you with a greater sense of financial freedom.
What is not an advantage of a savings account? ›
Answer and Explanation: C) Protections against inflation is not a benefit of a savings account. Inflation is a decrease in the value of cash over time due to financial and monetary policy that means that prices of goods and services increase faster than the value of money.
What is the difference between a standard traditional savings account from a traditional bank vs a high yield savings account? ›
The biggest difference is the interest rate, or yield, usually called an annual percentage yield (APY). This is the interest you earn on your savings over a year. A traditional savings account earns anywhere from 0.01% to 0.35% on the money in your account. But a high-yield savings account earns much more than that.
National average savings account interest rates
The national average yield for savings accounts is 0.6 percent APY as of May 17, 2024, according to Bankrate's most recent survey of institutions. Many online banks have savings interest rates higher than the national average savings account interest rates.
What is the difference between a traditional savings account and an online savings account? ›
Overall, online savings accounts offer convenience and 24x7 accessibility, while traditional savings accounts provide a physical presence, potential relationship benefits, and a more familiar banking experience.
What are the 5 disadvantages of money? ›
The following are the various disadvantages of money:
- Demonetization - ...
- Exchange Rate Instability - ...
- Monetary Mismanagement - ...
- Excess Issuance - ...
- Restricted Acceptability (Limited Acceptance) - ...
- Inconvenience of Small Denominators - ...
- Troubling Balance of Payments - ...
- Short Life -
The Benefits of Saving Money
- Starting a savings account may help you cover a financial emergency without taking on expensive debt.
- Savings accounts may also help you achieve financial stability and peace of mind.
- With a savings account, you can better plan for retirement and leave a legacy behind for your loved ones.
Despite its perks, saving does have some drawbacks, including: Returns are low, meaning you could earn more by investing (but there's no guarantee you will.) Because returns are low, you may lose purchasing power over time, as inflation eats away at your money.
What is a drawback of a regular savings account quizlet? ›
A drawback of a regular savings account is. low rate of return.
What are some of the disadvantages 3 of not being in the traditional banking system? ›
Being unbanked means things like cashing checks and paying bills are costly and time-consuming. Those who are unbanked often must rely on check cashing services to cash paychecks because they don't have direct deposit. They also have to pay bills using money orders, which adds time and expense to the process.
Which is a disadvantage of investing in a savings account Quizlet? ›
Which is a disadvantage of investing in a savings account? The rate of return fails to keep up with inflation.
