Yes, most savings accounts earn interest, but the rate varies widely
A savings account earns interest when the bank pays you a percentage of the money you keep deposited there. The bank uses your money to lend to other customers and invests it; in return, they share a small portion of what they make with you. The amount you earn depends on the annual percentage yield (APY) the bank offers, how much you have in the account, and how long it stays there.
Not every savings account earns the same rate. A traditional bank might offer 0.01% APY, meaning you'd earn about $1 per year on a $10,000 balance. An online bank might offer 4% to 5% APY on the same $10,000, earning you $400 to $500 per year. The difference comes down to the bank's operating costs and how much they need to attract deposits.
Interest compounds, which means you earn interest on your interest. If your account compounds daily, the bank calculates and adds interest to your balance every single day. Over months and years, this compounds into noticeably more money than if interest were calculated once a year.
Key Takeaways
- Banks pay interest on savings accounts as a percentage of your balance, called the annual percentage yield (APY), which varies from nearly 0% at traditional banks to 4% to 5% at online banks.
- Interest compounds, meaning you earn interest on the interest already added to your account, so the longer money sits, the more it grows.
- The APY a bank advertises is the rate you'll earn if you leave money untouched for a full year; rates can change at any time.
- High-yield savings accounts at online banks typically pay more than traditional bank savings accounts because online banks have lower overhead costs.
- Money market accounts and certificates of deposit (CDs) may pay higher rates than savings accounts, but they come with different rules about withdrawals.
How interest rates are set and why they change
Banks set their own interest rates based on the federal funds rate, which is the interest rate the Federal Reserve charges banks to borrow from each other. When the Fed raises its rate, banks typically raise the rates they offer on savings accounts. When the Fed lowers its rate, banks usually lower savings account rates too.
The relationship is not one-to-one. A bank might raise its savings rate by 0.5% when the Fed raises its rate by 1%, or it might raise it by less. Banks compete for deposits, so some move faster than others. Online banks often respond more quickly to Fed changes because they have fewer branches and lower costs to cover.
Banks can change your rate at any time, even if you've had the account for years. They must notify you before the change takes effect, usually by email or mail. Your rate is not locked in unless you have a certificate of deposit (CD), which guarantees a fixed rate for a set period.
How to calculate what you'll earn
The formula is straightforward: multiply your balance by the APY, then divide by the number of days in a year. If you have $5,000 in an account earning 4.5% APY, you'd earn roughly $225 per year, or about $18.75 per month. If the rate compounds daily, you'll earn slightly more because interest gets added to your balance each day and then earns interest itself.
Most banks show you the projected interest on their website or in your account dashboard. You can also use an online calculator: enter your balance, the APY, and how long you plan to leave the money there, and it will show you the total interest earned.
Keep in mind that the APY advertised today may not be the rate you earn next month. If the Fed cuts rates, your bank will likely cut yours too. If you want to lock in a rate, you'd need to move money into a CD, which holds the rate steady for a fixed term (usually three months to five years).
The difference between savings accounts, money market accounts, and CDs
A savings account lets you deposit and withdraw money whenever you want, with no penalty. Interest rates are typically lower because the bank can't count on your money staying there. You can make up to six withdrawals per month without penalty, though some banks have removed this limit.
A money market account combines features of savings and checking accounts. It usually pays a higher interest rate than a savings account, but it may require a larger minimum balance and limits how many times you can withdraw per month. Some money market accounts come with a debit card or checkbook.
A certificate of deposit (CD) locks your money in for a set period—three months, six months, one year, or longer. In exchange, the bank pays a higher interest rate than a savings account. If you withdraw before the term ends, you pay a penalty, usually a few months' worth of interest. CDs are useful if you know you won't need the money for a specific amount of time.
Where to find the highest rates
Online banks and credit unions typically offer the highest savings account rates because they have lower operating costs than brick-and-mortar banks. As of early 2024, online banks were offering rates between 4% and 5.35% APY on savings accounts, while traditional banks were offering 0.01% to 0.5%.
Rates change frequently, so the highest rate today may not be the highest next month. Before moving your money, check the bank's website directly and compare at least three options. Look for banks that are FDIC-insured (for banks) or NCUA-insured (for credit unions), which means your deposits are protected up to $250,000 if the institution fails.
Some banks offer promotional rates for new customers—a higher rate for the first few months, then a drop to their standard rate. Read the fine print to see when the promotional period ends and what the regular rate will be.
What happens to your interest if you withdraw money early
If you withdraw money from a savings account before the end of a month, you typically don't lose the interest you've already earned. The bank calculates interest daily, so you keep whatever has been added to your balance up to the day you withdraw.
The exception is a CD. If you withdraw before the maturity date, you pay an early withdrawal penalty. The penalty varies by bank and CD term—it might be 30 days of interest, 90 days of interest, or a percentage of the balance. Some banks waive the penalty if you withdraw within a certain grace period after the CD matures.
Savings accounts have no early withdrawal penalty, but some banks limit how many times you can withdraw per month. If you exceed the limit, they may charge a fee per extra withdrawal or close your account.
How taxes affect the interest you keep
Interest earned in a savings account is taxable income. At the end of each year, your bank sends you a Form 1099-INT showing how much interest you earned. You report this on your tax return, and you owe federal income tax on it at your regular tax rate.
If you earned more than $10 in interest during the year, the bank must send you a 1099-INT. If you earned less, they may not send one, but you still owe tax on it if you file a return.
State income tax may also apply, depending on where you live. Some states don't tax interest income, while others do. Check your state's tax rules or talk to a tax preparer if you're unsure.
Frequently Asked Questions
Can I lose money in a savings account?
No, you cannot lose the principal (the money you deposit). The bank cannot take your balance below what you put in. However, if inflation rises faster than your interest rate, your money loses purchasing power—it buys less than it used to. A 0.01% rate in a high-inflation year means you're effectively losing money in real terms.
What's the difference between APY and APR?
APY (annual percentage yield) includes compounding, so it shows the total you'll earn in a year. APR (annual percentage rate) does not include compounding. For savings accounts, always look at the APY, because that's what you'll actually earn.
Is my money safe in a savings account?
Yes, if the bank is FDIC-insured. The FDIC protects up to $250,000 per depositor, per bank. If the bank fails, the FDIC pays you back. Credit unions are insured by the NCUA up to the same amount. Check the bank's website or the FDIC website to confirm coverage.
Should I move my money to get a higher rate?
If your current bank pays 0.01% and another bank pays 4.5%, moving could earn you hundreds of dollars per year on a large balance. The move itself is free—you can transfer money between banks without penalty. However, consider how often you access the account and whether the new bank has features you need.
What happens to my interest if the bank lowers its rate?
Interest you've already earned stays in your account. Only new interest going forward is calculated at the lower rate. If you want to lock in a rate, move money into a CD before the rate drops, or switch to a bank offering a higher rate.