What banks pay you depends on the account type and the current interest rate environment

Banks pay you interest on savings accounts, money market accounts, and certificates of deposit (CDs). The amount varies widely—from nearly zero to over 5 percent annually, depending on which bank you use, what type of account you open, and what the Federal Reserve's current rate is. A savings account at a large national bank might pay 0.01 percent, while an online bank's savings account might pay 4.5 percent on the same balance. The difference compounds: on $10,000, that's $1 per year versus $450 per year.

Banks set their own rates within limits set by the Federal Reserve. When the Fed raises its benchmark rate, banks eventually raise what they pay depositors—but not always by the same amount, and not always quickly. When the Fed cuts rates, banks drop their rates faster than they raised them. This means the best-paying account today might not be the best-paying account in six months.

Key Takeaways

  • Online banks typically pay 4 to 5 percent on savings accounts, while large national banks pay closer to 0.01 to 0.05 percent on the same product.
  • Money market accounts usually pay slightly more than savings accounts but require a higher minimum balance and limit how many withdrawals you can make per month.
  • Certificates of deposit (CDs) lock your money away for a set term—three months to five years—but pay a fixed rate that does not change, even if the Fed cuts rates.
  • The interest rate your bank pays is separate from the interest rate you pay on a loan; banks profit by paying you less than they charge borrowers.
  • Interest is taxed as ordinary income, so a 5 percent rate on $10,000 means $500 in interest that you must report to the IRS.

How savings account rates are set and why they vary so much

Banks decide their own rates based on what they need to attract deposits and what they can earn by lending that money out. A large bank with millions of customers does not need to pay much interest to keep deposits—people stay because of the branch network or the app. An online bank with no physical locations has to pay more to compete for the same dollars. During periods when the Fed's rate is high, competition for deposits is fierce and rates climb. When the Fed cuts rates, banks cut faster because they can afford to—depositors have fewer places to turn.

The Federal Reserve's benchmark rate (called the federal funds rate) is not the rate banks pay you. It is the rate banks charge each other for overnight loans. But it sets the floor for everything else. When the Fed's rate is 5.25 to 5.5 percent, online banks can afford to pay 4.5 to 5 percent on savings. When the Fed's rate drops to 3 percent, those same banks might pay 3.5 to 4 percent. Large national banks lag behind both directions—they raise rates slowly when the Fed moves up, and they cut rates quickly when the Fed moves down.

Savings accounts versus money market accounts versus CDs

Savings accounts are the most flexible. You can deposit and withdraw money whenever you want, with no penalty. In return, the interest rate is usually the lowest of the three options. As of early 2024, online banks pay 4 to 5 percent on savings accounts, while national banks pay 0.01 to 0.1 percent. There is no minimum balance requirement at most banks, though some require $25 or $100 to open.

Money market accounts sit between savings and CDs. They pay slightly more interest than savings accounts—typically 0.5 to 1 percent higher—but require a higher minimum balance (often $2,500 to $10,000) and limit you to six withdrawals per month under federal rules. If you exceed that limit, the bank can close the account or convert it to a savings account. Money market accounts also come with a debit card and checks, making them feel more like checking accounts.

Certificates of deposit (CDs) lock your money away for a fixed term: three months, six months, one year, three years, or five years. In exchange, the bank pays you a fixed rate that does not change, no matter what happens to the Fed's rate or the economy. A one-year CD might pay 4.5 percent while a five-year CD pays 4.75 percent. If you withdraw the money before the term ends, you pay a penalty—usually three to six months of interest. CDs are useful if you know you will not need the money and want to lock in a rate before it falls.

How interest is calculated and when you receive it

Banks calculate interest using one of two methods: simple interest or daily compounding. Most banks use daily compounding, which means they calculate interest on your balance every single day, then add that daily interest to your account. The next day, they calculate interest on the new, slightly higher balance. Over a year, this compounds and you earn more than simple interest would give you.

The formula is straightforward: your balance multiplied by the annual interest rate, divided by 365 days. On a $10,000 balance at 4.5 percent, that is $10,000 × 0.045 ÷ 365 = $1.23 per day. After 30 days, you have earned about $37. After a full year, you have earned $450. Banks usually credit interest monthly, though some credit it daily or quarterly. Check your account statement to see when your bank deposits it.

Interest is taxed as ordinary income. If you earn $450 in interest in a calendar year, you must report that $450 to the IRS on your tax return. Your bank will send you a 1099-INT form by January 31 if you earned $10 or more in interest during the year. This is separate from any taxes withheld from your paycheck—it is income you earned on money you already have.

Why large banks pay so little and what to do about it

National banks like Bank of America, Wells Fargo, and Chase pay 0.01 to 0.1 percent on savings accounts because they do not have to compete for deposits. Millions of people keep accounts there for convenience, direct deposit, or because they have a mortgage or credit card with the same bank. The bank knows most of these customers will not move their money, so it can pay almost nothing and still keep the deposits. The bank then lends that money out at 6 to 8 percent or higher, pocketing the difference.

If you keep $10,000 in a Bank of America savings account at 0.05 percent, you earn $5 per year. The same $10,000 at an online bank paying 4.5 percent earns $450 per year. Over five years, that is a difference of $2,225 in interest you do not receive. Moving your savings to an online bank or a credit union takes 15 minutes and costs nothing. The trade-off is that you lose the ability to walk into a branch, but most people rarely need that.

Credit unions often pay more than large national banks but less than online banks. They are member-owned, so they return profits to members through higher rates and lower fees. If you belong to a credit union, check what they pay on savings before moving money to an online bank.

What happens when the Fed changes rates

When the Federal Reserve raises its benchmark rate, banks do not immediately raise what they pay you. There is usually a lag of one to three months before online banks raise their rates, and large national banks lag even further—sometimes six months or longer. When the Fed cuts rates, banks cut their rates within days or weeks. This asymmetry is how banks protect their profit margin: they keep the extra money when rates rise, and they pass cuts along quickly when rates fall.

If you lock money into a CD before the Fed cuts rates, you keep earning the higher rate for the entire term. If you lock money into a CD right before the Fed raises rates, you miss out on the higher rate until the CD matures. This is why CD laddering—buying multiple CDs with different maturity dates—can be useful. You get some money back every few months, and you can reinvest it at the new, higher rate if rates have risen.

How to find the highest-paying account for your situation

The highest-paying savings accounts are almost always at online banks or credit unions, not at national banks. Websites like Bankrate, DepositAccounts, and NerdWallet track rates across hundreds of banks and update them daily. You can filter by account type (savings, money market, CD), term length (for CDs), and minimum balance. Compare at least three banks before opening an account.

Before you move money, check whether your current bank charges a fee to close the account or whether there is a minimum balance requirement you might fall below. Most online banks have no monthly fees and no minimum balance, but read the terms. Also confirm that the bank is FDIC-insured (for banks) or NCUA-insured (for credit unions). This insurance protects your money up to $250,000 per account type at each institution if the bank fails.

If you have more than $250,000 in savings, you can spread it across multiple banks to keep all of it insured. A $500,000 savings account at one bank is only insured up to $250,000; the other $250,000 is at risk. Split it into two accounts at two different banks, and both are fully insured.

Frequently Asked Questions

Do I have to pay taxes on the interest I earn?

Yes. Interest is taxed as ordinary income at your regular tax rate. If you earn $500 in interest and you are in the 24 percent tax bracket, you owe $120 in federal income tax on that interest. Your bank sends you a 1099-INT form by January 31 if you earned $10 or more. You report this on your tax return.

What is the difference between APY and APR?

APY (annual percentage yield) is what banks use for savings accounts and CDs. It includes the effect of compounding—earning interest on your interest. APR (annual percentage rate) is what banks use for loans and credit cards. It does not include compounding. When comparing savings accounts, always look at APY, not the stated rate.

Can a bank change the interest rate on my savings account?

Yes. Banks can raise or lower the rate on savings accounts and money market accounts at any time, with no notice required. CDs are different—the rate is locked in for the entire term. If you want to lock in a rate before it falls, a CD is the only way to do it.

What happens to my interest if I withdraw money before the end of the month?

For savings and money market accounts, you still earn interest on the money you had in the account, calculated daily. If you had $10,000 for 20 days and then withdrew it, you earn interest for those 20 days. For CDs, withdrawing early triggers a penalty—usually three to six months of interest, which the bank deducts from your principal.

Is an online bank safe if it fails?

Yes, as long as it is FDIC-insured. Your deposits are protected up to $250,000 per account type per bank, the same as at a national bank. Check the bank's website or the FDIC's website to confirm it is insured. If the bank fails, the FDIC pays you directly, usually within a few business days.