MMAs? CDs? How the Major Types of Bank Accounts Differ
Banks offer many types of accounts, and chances are you have one, because only 6.5% of Americans don’t — an all-time low, according to the FDIC. Bank accounts are an essential part of life, allowing you to pay bills, save for a home and more, but how much do you really know about them?
These common types of accounts, which most banks and credit unions offer, help people manage spending, minimize fees and reach their savings goals:
All of the following are federally insured by the FDIC for up to $250,000 unless otherwise noted.
Checking Accounts
These simple products are for everyday banking like depositing checks, making cash withdrawals and transferring funds. Since the advent of direct deposit, workers can have their pay sent directly to their bank accounts.
You may write old-fashioned checks, but most users prefer a debit card for buying groceries or withdrawing cash at ATMs. Modern banks also offer convenient online bill-pay services as well as mobile check deposit.
You could put your money to work for you in a high-yield checking account. These types of bank accounts earn anywhere from 2 to 4% annual percentage yield (APY), but there are some caveats. For instance, there may be monthly limits on the number of transactions.
Advantages: Basic checking accounts are versatile and convenient to use. Most offer services and support 24/7.
Downsides: Some banks will bury you in fees. Others require a certain minimum balance.
Tips: Take advantage of direct deposit. Balance your account at least once a month, and routinely check for suspicious activity.
Savings Accounts
People of all ages use these to sock away future wealth. They’re ideal for establishing longtime banking relationships, and that comes in handy when it’s time to buy a first car or starter home.
This is one of the best types of accounts for an emergency fund because withdrawals are usually capped or discouraged.
Unfortunately, savings account interest rates have never fully rebounded from the 2008 recession. As of January 2019 the national average was an abysmal 0.09%, as reported by the FDIC.
However, you can get a little more bang for your buck with a high-yield savings account. Some online banks currently offer anywhere from 2 to 2.4% APY, like CIT Bank.
Just watch out for fees, initial deposit and minimum balance requirements. Find out how the interest is compounded; the more often it’s compounded, the greater the yield will be.
Advantages: Savings accounts help users set long- and short-term financial goals, earn a little extra, and resist the temptation to spend. Young account holders learn responsibility and discipline. Oh, and did we mention they're federally insured?
Downsides: The minimum initial deposit may be quite high, and you might miss the convenience of a debit card.
Also, most savings accounts have a lower yield than money market accounts or certificates of deposit.
Tips: If you lack the discipline to save, set up automatic payday transfers from your checking account.
Certificates of Deposit (CDs)
CDs are more rewarding than checking or savings accounts, but you’ll have to kiss your money goodbye for a while. The term length can be anywhere from a few months to 10 years. The longer it is, though, the more you will earn.
CDs have a fixed interest rate and a preset date of withdrawal, which is called the maturity date. If you prematurely withdraw funds, you pay a penalty.
Advantages: CD rates can be significantly higher than interest rates on savings accounts. There are usually no fees. The funds are insured, the rates are locked in, and the returns are guaranteed.
Downsides: Withdrawing money early could prove very costly, and CD rates don’t always keep up with inflation.
Tips: Shop around. Rates vary widely among different institutions.
Buy CDs of different term lengths such as six months, 18 months, two years and four years. Keep an eye on current rates. If they improve, reinvest the matured short-term CDs for new ones with better rates.
Money Market Accounts (MMAs)
MMAs pay slightly higher interest rates than ordinary savings accounts.
Banks use the funds in MMAs to invest in CDs, government bonds and other low-risk investments. The higher MMA interest rate is a share of the returns on investment.
MMAs shouldn’t be confused with money market mutual funds, which are not federally insured.
Advantages: MMAs, especially those with high balances, earn more interest than some other types of accounts. Many offer conveniences like debit cards and personal checks.
Downsides: Minimum deposit and balance requirements tend to be high. You're limited on how often you can withdraw funds. MMA rates fluctuate, so there are no guarantees.
Tips: Don’t think of an MMA as a long-term investment vehicle. It’s best for things like building an emergency fund or saving for a big purchase in the near future.
Make sure that the advertised rate is not just a promotional offer. That goes for all types of bank accounts.
Retirement Accounts
Two words sum up the appeal of retirement accounts: tax savings.
The Roth individual retirement account, or Roth IRA, is a popular choice offered by banks.
You can’t deduct contributions, but withdrawals — including your investment earnings — are tax-free in retirement. And, through the miracle of compound interest, the earnings can be a beautiful thing.
Let’s say that starting at age 20, you contributed $5,000 a year to a Roth IRA, and let's assume the investments grow by an average 8% each year. Your savings would balloon to more than $2 million by the time you reached 65.
Advantages: Roth IRAs grow at exponentially faster rates than ordinary savings accounts. The greatest benefit is having a sizable sum tucked away for the golden years.
Downsides: Keeping track of the rules is possibly the biggest negative. Plus, not all money held in a Roth IRA is federally insured — only Roth funds that are invested in federally insured bank products, like CDs and savings accounts, receive protection.
The Roth IRA has limits on how much you can earn to be eligible. You’ll pay steep penalties for withdrawing funds before retirement age.
Tips: Talk over your circumstances with an experienced accountant for advice about the best way to save. The IRS website also offers a wealth of information on retirement accounts and how they’re taxed, so do your homework.
Getting the most out of your bank account is a lot easier when you know your options.
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