What a savings account earns depends on the interest rate and how much you have saved
A savings account earns money through interest—a percentage of your balance that the bank pays you each year. The amount you earn is calculated by multiplying your account balance by the interest rate the bank offers. If you have $10,000 in an account earning 4.5% annual interest, you earn $450 per year. If the same account earns 0.01%, you earn $1 per year on that same $10,000.
Interest rates vary widely between banks and change over time. Online banks typically offer higher rates than brick-and-mortar banks. The Federal Reserve sets a benchmark rate that influences what banks offer, so rates rise and fall based on economic conditions. Right now, rates range from nearly 0% at some traditional banks to 4% to 5% at online banks, though these numbers shift regularly.
Most savings accounts compound interest monthly or daily, meaning you earn interest on your interest. If you leave your earnings in the account, next month's interest is calculated on your original balance plus the interest you already earned. This compounding effect is small with low balances but becomes meaningful over years or with larger amounts.
Key Takeaways
- Your annual earnings equal your account balance multiplied by the interest rate—a $5,000 balance at 4% earns $200 per year.
- Online banks currently offer rates between 4% and 5%, while traditional banks often offer less than 1%.
- Interest rates change based on Federal Reserve decisions, so the rate you see today may be different in six months.
- Compounding means you earn interest on your interest, so money left untouched grows faster over time.
- The difference between a 0.5% account and a 4.5% account on $10,000 is roughly $400 per year in lost earnings.
How interest rates are set and why they change
Banks set their own interest rates, but they follow the Federal Reserve's benchmark rate, called the federal funds rate. When the Fed raises its rate, banks typically raise what they pay on savings accounts. When the Fed lowers its rate, savings account rates usually fall within weeks or months. The Fed adjusts its rate based on inflation and economic conditions, so rates can shift several times per year.
Online banks tend to pass rate changes to customers faster than traditional banks because they have lower overhead costs. A traditional bank might offer 0.01% while an online bank offers 4.5% for the same type of account. This gap has widened in recent years as online banking has become more common. If you keep money in a low-rate account, you are leaving hundreds or thousands of dollars on the table each year.
Calculating what you will earn on your specific balance
To find your annual earnings, use this formula: Balance × Interest Rate = Annual Earnings. If you have $25,000 at 4.5%, multiply $25,000 by 0.045 to get $1,125 per year. If the rate is 0.5%, the same balance earns $125 per year—a difference of $1,000.
Most banks show your interest rate as an APY, which stands for Annual Percentage Yield. This number already accounts for compounding, so you can use it directly in the calculation above. Some older accounts or promotional rates may show APR instead, which does not include compounding, but savings accounts almost always use APY.
If your balance changes during the year, your earnings change too. A balance of $10,000 for six months and $15,000 for six months at 4% earns roughly $500 for the year (the average balance of $12,500 times 4%). Banks calculate this daily, so deposits and withdrawals are reflected in your next interest payment.
How compounding increases your earnings over time
Compounding happens when interest is added to your account and then earns interest itself. If you start with $10,000 at 4% compounded monthly, after one month you have $10,033.33. The next month, you earn interest on $10,033.33, not just the original $10,000. After one year, you have $10,407.07—$7.07 more than simple interest would give you.
The longer money sits untouched, the more compounding matters. After five years at 4% compounded monthly, $10,000 grows to $12,209.97. After ten years, it reaches $14,918.13. The difference between monthly and daily compounding is small, but daily compounding is slightly better because interest accrues more often.
Compounding works against you too—if you carry a credit card balance, interest compounds daily and costs you money. But in a savings account, compounding is assistance programs as long as you leave the balance alone.
Comparing earnings across different account types and rates
A high-yield savings account typically earns 4% to 5.5%, while a traditional savings account at a large bank earns 0.01% to 0.5%. Money market accounts often offer rates similar to high-yield savings. Certificates of Deposit (CDs) usually offer higher rates—sometimes 5% to 5.5%—but lock your money away for a set period, usually three months to five years.
On a $50,000 balance, the difference between 0.5% and 4.5% is $2,000 per year. Over five years, that gap grows to more than $10,000 when compounding is included. This is why moving money from a low-rate account to a high-rate account can be worth the effort, even if the bank is less familiar.
| Account Type | Typical Rate Range | Annual Earnings on $10,000 | Annual Earnings on $50,000 |
|---|---|---|---|
| Traditional bank savings | 0.01% to 0.5% | $1 to $50 | $5 to $250 |
| High-yield savings | 4% to 5.5% | $400 to $550 | $2,000 to $2,750 |
| Money market account | 3.5% to 5% | $350 to $500 | $1,750 to $2,500 |
| CD (1-year) | 4.5% to 5.5% | $450 to $550 | $2,250 to $2,750 |
What happens to your earnings if rates drop
When the Federal Reserve lowers its benchmark rate, banks lower the rates they pay on savings accounts. If you are in a high-yield account earning 5% and rates fall, your bank may drop the rate to 3% or lower within weeks. Your balance does not shrink, but your annual earnings do. A $50,000 balance earning $2,500 per year at 5% drops to $1,500 per year at 3%—a loss of $1,000 in annual income.
Some accounts offer promotional rates that are may provide for a limited time, then drop to a lower standard rate. Read the fine print before opening an account to understand when a promotional rate expires. If rates are falling, locking in a CD at a fixed rate can protect your earnings, since CD rates do not change once the CD is opened.
Taxes on savings account interest
Interest earned in a savings account is taxable income. If you earn $500 in interest during the year, that $500 counts as income on your tax return. The bank will send you a 1099-INT form in January showing how much interest you earned. You report this on your federal tax return, and depending on your tax bracket, you may owe federal income tax on it.
State income tax may also apply, depending on where you live. Some states do not tax interest income, while others do. The tax you owe on $500 in interest might be $75 to $150, depending on your tax bracket. This is why the real return on a savings account is lower than the stated interest rate—you keep only what is left after taxes.
Frequently Asked Questions
How often does a bank pay interest on a savings account?
Most banks pay interest monthly, though some pay quarterly or daily. Daily accrual means interest is calculated every day but paid monthly. The frequency does not change your annual total much, but daily accrual is slightly better because compounding happens more often.
Can I lose money in a savings account?
No. Your balance is protected by FDIC insurance up to $250,000 per bank. You cannot lose your principal, but if interest rates fall, your earnings shrink. Inflation can also reduce what your money buys, even if the account balance stays the same.
Is a high-yield savings account safe?
Yes, as long as the bank is FDIC-insured. Online banks that offer high rates are regulated the same way as traditional banks. Your money is just as protected at an online bank earning 4.5% as it is at a brick-and-mortar bank earning 0.5%.
What is the difference between APY and APR on a savings account?
APY includes compounding, while APR does not. Savings accounts use APY, so the rate shown is what you actually earn. APR is used for loans and credit cards. Always look for APY when comparing savings accounts.
Should I move my money to a higher-rate account?
If your current account earns less than 1% and you have more than $5,000 saved, moving to a 4% account will earn you hundreds of dollars per year. The process takes a few days and involves no risk. The main cost is the time it takes to open a new account and transfer money.