Basics of High-Yield Savings Accounts

Everyone wants to make smart money decisions. One way to grow your money safely is to save it in an interest-bearing account. Banks, credit unions, and other financial institutions offer high-yield savings accounts with higher interest rates than most savings accounts. Read on for an explanation of how HYSAs work and how you can tell if one is right for you.

What is a high-yield savings account?

A high-yield savings account (HYSA) is a savings account that pays a higher interest rate than traditional savings accounts. This rate often is 10 to 20 times greater than the national average for savings accounts. But high-yield accounts entail no greater risk. Balances are federally insured for at least $250,000.

Who uses a high-yield savings account and why?

An HYSA is a good option for almost everyone with savings. This can include people who are building an emergency cash reserve, those working towards goals like paying for a vacation or purchase, and individuals who are saving for life milestones such as a down payment on a house or wedding.

During times of stable or rising interest rates, high-yield savings accounts are especially attractive compared to some other products such as Treasury Bills (T-Bills) and certificates of deposit (CDs) because they offer flexibility and higher returns without sacrificing safety.

What are key terms to understand?

To assess whether a high-yield savings account is right for you, there are some concepts to understand.

Compounding, compound interest - Compounding is the process of adding interest to your principal balance. Suppose you have $1,000 in an HYSA that is earning 4% annual percentage yield (APY) interest rate that compounds annually. At the end of the year, you would have $1,040 in the account. In the second year, you would earn interest on your original principal of $1,000 as well as the additional $40. If you leave the money in your account, you’d have $1,081.60 at the end of the second year. If compounding occurs daily, monthly, or quarterly, this helps your money grow faster.

Here is the scenario assuming a $1000 deposit earning interest at 4% APY over 5 years compounding annually:

Time	Deposit
Start	$1000
After 1 year	$1040
After 2 year	$1081.60
After 3 years	$1123.86
After 4 years	$1169.86
After 5 years	$1216.85

APY - This stands for annual percentage yield. It tells you the actual rate of return on your HYSA after compounding, if you keep all the money in your account for a year. The more frequently interest is compounded, the higher your APY will be. If compounding occurs daily, every day you’ll earn interest on a slightly greater balance. An account that compounds annually will only increase its interest-earning amount once a year. The APY quantifies this effect. So an account with a 5% interest rate that compounds annually would have an APY of 5%, but one that compounds daily would have an APY of 5.13%.

Minimum deposit - A bank may require a minimum amount of money to open a new HYSA. This is the minimum deposit.

Minimum balance - This is the minimum you need to hold in the HYSA. The minimum could be based on a daily balance, monthly balance, or an average depending on the instituion. Not all high-yield savings accounts have a minimum balance.

Maintenance fee - Some banks charge a monthly fee to maintain an HYSA, which decreases your return. Having a balance over a certain threshold can sometimes avoid this fee.

How does a high-yield savings account work?

A high-yield savings account works similarly to a regular savings account. HYSAs are best used to keep money that you do not expect to need for daily expenses.

Traditionally, regulations limited the number of so-called convenient withdrawals (such as check transactions) from both HYSA and regular savings accounts to six per month before fees or penalties. Those regulations have changed, but some banks maintain the restrictions. First Fed does not.

Some HYSAs offer ATM access and/or check writing along with online banking, mobile deposit, and other services. But typically these accounts are not intended to be used for everyday spending or bill paying.

Policies vary by bank, but some HYSAs require minimum opening deposits or average balances. Some institutions charge a monthly fee but will waive it if you maintain a certain balance.

The one crucial distinction with HYSAs is the superior interest rate compared to regular savings accounts. It’s important to look at the APY because the yield reflects the effect of compounding. That makes it possible to compare accounts on an equivalent basis.

Pros and cons of high-yield savings accounts

The prospect of getting a higher rate of return on your savings makes high-yield savings accounts attractive, and that is the biggest advantage of these accounts. The higher APY means your money grows more quickly without any additional effort.

There are other pros and cons to consider as well. These are some of the pros:

You can add to an HYSA at any time, unlike a certificate of deposit, savings bond, or Treasury bill.
You can automate your savings to an HYSA by setting up regular deposits from your paycheck and stay on track with your goals.
You can easily separate your savings and your other money including your funds for daily expenses. Not seeing the dollars in your checking account may deter you from spending this money.
HYSAs may discourage impulse purchases because your money is not accessible with a debit card.
Deposit insurance means your savings are completely safe up to certain thresholds, backed by federal guarantee.

The cons of high-yield savings accounts include the following:

HYSAs at some banks have restrictions that make it more difficult to access your money conveniently through electronic transfers and checks.
There may be a minimum balance requirement or a fee. Note: This is not the case at First Fed.
Interest rates can change up or down, so your yield is not always predictable. That means you can’t count on ending the year with a known amount of interest. Moreover, the rate of inflation can exceed the interest rate resulting in a negative real return.
There may be alternatives that provide greater return, such as investing.
Some high rates on HYSAs are offered by banks that are online only with no branch locations. That makes it very difficult to talk to staff and do business in person. This is not the case with First Fed.

HYSAs compared to other popular financial products

In deciding whether a high-yield savings account is right for you, you’ll want to compare it to other options. Here are the main points of difference between HYSAs and some other popular alternatives.

HYSA vs Traditional Savings
These two accounts are very similar except the high-yield account offers a much higher interest rate.

HYSA vs Money Market Accounts

A money market account (MMA) acts as a hybrid of a checking and savings account. Money market accounts are offered by banks and are insured by the FDIC. MMAs are more likely to come with checks and debit cards, making it easier to spend money in the account, even though MMAs often have monthly limits on checks or transfers.

On the downside, the interest rates on money market accounts generally are only a small bit better than on traditional savings accounts. There may be exceptions since there is no formal reason MMAs cannot pay rates that are competitive with HYSAs.

HYSA vs Certificate of Deposits (CDs)

CDs are another type of bank account that can offer a relatively high interest rate, sometimes higher than the HYSA. The most important difference is that CDs have a set term, an amount of time in which you can only withdraw money by paying a penalty.

Terms can range from one month to five years. Generally, the rate increases as the term lengthens. This inaccessibility makes certificates of deposit a poor choice for an emergency fund.

With a CD, you know upfront the APY you will receive for the entire term while rates on HYSAs can change without notice. In a period of falling interest rates, this can make certificates of deposit attractive. When interest rates are rising, short-term CDs or HYSAs give you more flexibility to take advantage of higher yields.

As one last point of difference, you can add money to an HYSA at any time. You fund a CD at the start of its term, and you cannot add funds over the course of its lifespan.

Is a high-yield savings account right for me?

If you are considering an HYSA, ask yourself these questions to decide if it’s a good choice for your circumstances:

Is this money I might need immediately? If you answer yes, an HYSA is probably not your best option because the account is not designed for regular spending such as bill paying. Many high-yield accounts do not offer check writing.
Can I be patient enough to let my money grow? The higher yield offered by the HYSA is only a benefit if your money stays in the account and earns interest. If you move money in and out frequently or are easily tempted to spend savings, the magic of high-yield compounding has little opportunity to work, and an HYSA would offer little advantage over a regular savings account.
Am I working towards a goal? If you want to build savings for a major purchase or life milestone, an HYSA can help you get there faster. Seeing your balance grow may motivate you to stick with or increase your savings habit.
Can I maintain a minimum balance or meet other requirements? If you sometimes don’t meet requirements such as maintaining a minimum balance, you will likely face fees that may exceed the interest you earn.

How to choose a high-yield savings account

If you have decided to open an HYSA, you will want to choose the right bank and account. Here are the steps to make your decision.

Compare rates - Shop around and look at the interest rates different banks are offering. Recognize that the bank with the highest rate today may not always be number one. So look for general patterns since you won’t want to move your account every time rates change.
Check compounding - Confirm how frequently each bank compounds interest since that can have a big impact on your return. Use APY to compare accounts on an equivalent basis.
Look into requirements - Understand any requirements such as opening balance, minimum balance, and fees. If there are fees, you may be able to avoid them by holding other accounts at the institution or maintaining a certain balance.
Confirm FDIC insurance - Some accounts that look like HYSAs are offered by brokerage firms and do not carry the same deposit insurance that bank HYSAs do.
Consider accessibility - Find out how you can access your money and get customer service. This includes whether the account offers checks, electronic transfers, mobile banking, or an ATM card, and whether there is phone support or a branch network. Look into the hours and locations.
Make your selection - Pick the account that offers the best combination of APY, convenience, and fees for your needs.

How to open an HYSA

Once you have chosen the financial institution, you are ready to fill out an application, which you can most often do online. Usually you will need to provide a driver’s license or passport, your Social Security number, and other basic personal information.

Then it’s time to fund your new account. You can do this in a number of ways:

Transfer from another account
Direct deposit from your paycheck
Write a check
Wire funds

While it’s unlikely, a bank may turn you down for an HYSA account if you have a poor banking history.

FAQs

These are some of the most common questions people have about HYSAs.

Will I owe tax on HYSA interest? - Interest on savings is U.S. taxable income, and banks are required to report it to the IRS. Whether you will owe tax on that money depends on your personal circumstances.
Are HYSA rates fixed? - No, rates can change at any time. In practice, rates generally do not change on a daily basis. Sometimes rates may stay steady for many months. The frequency of changes reflects federal government interest rate policies.
Can you lose money in an HYSA? No, not if your account totals are under federal insurance thresholds. However, the spending power of your money can decline if the interest rate does not keep up with inflation.
How much interest will I earn on $1,000 in a year? $100,000? The amount of interest you receive depends on the rate and frequency of compounding. Those are both reflected in APY. If the APY is 4% with annual compounding, you would earn $40 of interest on $1,000 in a year. On $100,000 you would earn $4,000.