What you earn depends on the bank's rate and how much you have saved
The amount of interest you earn in a savings account is determined by two things: the annual percentage yield (APY) the bank offers and the balance you keep in the account. A bank paying 4.5% APY on $10,000 will pay you roughly $450 per year (before taxes). The same bank paying 0.01% APY on the same $10,000 will pay you about $1 per year. The difference between these two scenarios is real money, and it matters which account you choose.
Interest compounds, meaning you earn interest on your interest. Most savings accounts compound daily or monthly, so the money you earn gets added to your balance and starts earning its own interest. This happens automatically — you do not have to do anything. The longer your money sits in the account, the more compounding works in your favor, but only if the APY is high enough to make it worth your time.
Key Takeaways
- Interest earned equals your account balance multiplied by the APY, divided by 365 days (or 12 months), then multiplied by the number of days (or months) your money was in the account.
- Banks with higher APYs — typically online banks and credit unions — pay significantly more than traditional brick-and-mortar banks, sometimes 40 to 50 times more on the same balance.
- Interest compounds daily or monthly depending on the bank, meaning you earn interest on the interest you already earned, but the effect is small unless you leave money untouched for years.
- The interest you earn is taxable income and must be reported on your tax return; banks send you a 1099-INT form if you earn $10 or more in a year.
- Moving money in and out of the account reduces the average daily balance and lowers the total interest you earn, even if the APY stays the same.
How banks calculate the interest you earn
Banks use a formula based on your daily balance. The calculation is: (balance × APY ÷ 365) × number of days the money was in the account. If you keep $5,000 in an account with a 4.5% APY for 30 days, you earn roughly $18.49. If you keep it there for a full year, you earn roughly $225.
Most banks compound interest daily, meaning they calculate what they owe you each day and add it to your balance. Some compound monthly or quarterly. Daily compounding is slightly better for you because the interest gets added more often and starts earning interest sooner, but the difference is usually small — a few dollars per year on typical balances.
The APY you see advertised is the rate you would earn if you left your money untouched for a full year. If you withdraw money partway through the month, the bank recalculates based on the lower average daily balance. If you deposit money midway through, the same thing happens — the interest is based on how long each dollar actually sat in the account.
Why APY varies so much between banks
Online banks and credit unions typically offer much higher APYs than traditional banks because they have lower overhead costs. A brick-and-mortar bank with physical branches, employees, and real estate pays more to operate, so it passes less of its profit to savers. An online bank with no branches and a small staff can afford to pay more.
As of late 2024, traditional banks often pay 0.01% to 0.05% APY on savings accounts, while online banks and credit unions pay 4% to 5.35% APY on the same type of account. On a $10,000 balance, the difference is roughly $400 to $500 per year. Over five years, that gap compounds to thousands of dollars.
APY also changes when the Federal Reserve raises or lowers interest rates. When the Fed raises rates, banks eventually raise the APY they offer on savings accounts (though not always immediately). When the Fed lowers rates, banks lower APYs. Your rate can change at any time unless the bank has locked it in a special promotional offer, which is rare.
The real impact of compounding over time
Compounding sounds powerful, but the effect depends on how long your money stays in the account and how high the APY is. On $10,000 at 4.5% APY compounded daily, you earn about $459 in year one. In year two, you earn about $480 because you are earning interest on the $459 you earned in year one. The difference between simple interest (no compounding) and compound interest is roughly $21 per year on this balance.
The longer you leave money untouched, the more compounding helps. After 10 years at 4.5% APY, your $10,000 grows to about $15,530 with daily compounding, versus $14,500 with simple interest. That is a $1,030 difference. But if you withdraw money frequently or move it to different accounts, you reset the compounding clock and lose that advantage.
Compounding matters most when you have a large balance, a high APY, and a long time horizon. If you are saving $500 per month for a house down payment over two years, compounding will add maybe $50 to $100 to your total. If you are saving $50,000 for retirement over 20 years, compounding can add thousands.
How taxes reduce what you actually keep
Interest earned in a savings account is taxable income. The bank reports it to the IRS on a 1099-INT form if you earn $10 or more in a calendar year. You must report this income on your tax return, and you owe federal income tax on it at your ordinary tax rate — not a special lower rate.
If you earn $450 in interest and you are in the 22% federal tax bracket, you owe roughly $99 in federal tax on that interest. Your state may also tax it. After taxes, you keep about $351 of the $450 you earned. This is why the after-tax return matters more than the headline APY.
Some people use tax-advantaged accounts like Roth IRAs or 529 college savings plans to earn interest without paying tax on it each year. These accounts have contribution limits and rules about when you can withdraw money, but the tax savings can be significant if you are saving for a specific goal like retirement or education.
Comparing what different account types pay
| Account Type | Typical APY Range | Interest on $10,000/Year | Best For |
|---|---|---|---|
| Traditional bank savings | 0.01% to 0.05% | $1 to $5 | Convenience, branch access |
| Online savings account | 4% to 5.35% | $400 to $535 | Maximum interest, no branches needed |
| Money market account | 4% to 5.25% | $400 to $525 | Interest plus check-writing ability |
| Certificate of deposit (CD) | 4.5% to 5.5% | $450 to $550 | Locked-in rate, money tied up for months or years |
| High-yield savings (credit union) | 4.5% to 5.35% | $450 to $535 | High interest, membership required |
The rates in this table vary by institution and change frequently. Shop around before opening an account, because the difference between a 0.05% account and a 5% account is the difference between earning $5 and $500 per year on the same $10,000.
Money market accounts sit between savings accounts and checking accounts — they pay interest like savings accounts but let you write checks or use a debit card like checking accounts. CDs lock your money away for a set term (three months to five years) in exchange for a higher rate. If you withdraw early, you pay a penalty that can wipe out months of interest.
What happens when you move money in and out
Every time you deposit or withdraw money, the bank recalculates your average daily balance for that period. If you keep $10,000 in an account for 15 days, then withdraw $5,000 and keep the remaining $5,000 for the next 15 days, your average daily balance for the month is $7,500, not $10,000. You earn interest only on the $7,500.
This is why frequent transfers reduce your total interest earned, even if the APY never changes. If you are using a savings account as an emergency fund and you withdraw money every few weeks, you are earning less interest than someone who deposits money once and leaves it alone. The trade-off is worth it if you need access to the money, but it is something to know.
Some accounts penalize you for withdrawals by charging a fee or lowering your APY. Federal rules used to limit savings account withdrawals to six per month, but that rule was suspended in 2020. Most banks no longer enforce withdrawal limits, but some still charge fees for frequent transfers. Read the account terms before opening.
Frequently Asked Questions
How often does interest get added to my account?
Most banks add interest monthly, though some add it daily or quarterly. Daily compounding is slightly better, but the difference is usually just a few dollars per year. Check your account terms to see when interest posts — the bank is required to disclose this.
Can I lose money in a savings account?
No. Your balance can only stay the same or grow. If the APY is very low (like 0.01%), your balance grows so slowly it might not keep up with inflation, but the bank cannot take money out. Your deposits are also protected up to $250,000 per depositor per bank by the FDIC (or NCUA if it is a credit union).
Is it better to put money in a CD or a savings account?
CDs usually pay slightly more APY than savings accounts, but you cannot touch the money without paying a penalty. If you need access to the money within a year or two, a high-yield savings account is better. If you know you will not need the money for a specific period, a CD locks in a higher rate and removes the temptation to spend it.
Do I have to report savings account interest on my taxes?
Yes, if you earn $10 or more in a year. The bank sends you a 1099-INT form, and you report the interest as income on your tax return. You owe tax on it at your ordinary income tax rate, which varies based on your total income and filing status.
What if my bank lowers the APY after I open the account?
Banks can change APY at any time unless they have offered a promotional rate with a specific end date. If your rate drops and you do not like it, you can move your money to a different bank. There is no penalty for closing a savings account and moving to another institution.