What you earn depends on the bank's rate, how much you deposit, and how long the money sits there

The amount of interest you earn on a savings account is determined by three things: the annual percentage yield (APY) the bank offers, the balance you keep in the account, and how long that money stays deposited. A bank offering 4.5% APY on $10,000 will pay you roughly $450 per year—but that rate can change, and different banks offer wildly different rates for the same type of account.

The interest compounds, meaning you earn interest on your interest. With monthly compounding (the most common), you earn a small amount each month, and the next month's interest is calculated on the new, slightly larger balance. Over a year, this compounding adds a small boost to your total earnings compared to simple interest.

Most savings accounts today earn between 0.01% and 5.35% APY, depending on the bank and the account type. Online banks typically offer higher rates than brick-and-mortar banks. The rate you see advertised is the rate the bank is currently offering to new customers—it is not locked in for life, and banks can lower it at any time.

Key Takeaways

  • Your earnings equal the APY multiplied by your balance, divided by 12 for a monthly estimate, though the exact amount depends on how often interest compounds.
  • Banks can change the APY on your account at any time, so a rate that looks good today may drop in three months.
  • Online banks and high-yield savings accounts typically pay 10 to 50 times more interest than traditional bank savings accounts.
  • Interest is taxed as ordinary income, so you will owe federal income tax on whatever you earn, and possibly state tax as well.

How the calculation actually works

The formula is straightforward: Interest = Balance × APY ÷ 12 (for a rough monthly estimate). If you have $5,000 in an account earning 4.5% APY, you earn roughly $187.50 per year, or about $15.63 per month. The bank calculates this daily or monthly depending on the account, and the interest lands in your account on a schedule the bank sets—usually monthly or quarterly.

Compounding makes the real number slightly higher than the simple calculation. With daily compounding, the bank calculates interest on your balance every single day, adds it to your account, and then the next day's calculation includes that new interest. Monthly compounding does the same thing once a month. The difference is small for most balances, but it adds up over time. A $10,000 balance at 4.5% APY with daily compounding earns about $460 per year instead of exactly $450.

The APY you see advertised already accounts for compounding, so you do not have to do a separate calculation. The bank is telling you: "If you leave $1 in this account for one year, you will have $1.045 at the end." The APY is the true annual return, not the stated rate before compounding is factored in.

Why rates vary so much between banks

Online banks pay higher interest because they have lower overhead costs—no physical branches, fewer employees, lower rent. They pass those savings to customers in the form of higher APY. A traditional bank with hundreds of branches might offer 0.01% APY on savings, while an online bank offers 4.75% on the same type of account. You are earning 475 times more interest at the online bank.

Banks also set rates based on what the Federal Reserve does. When the Fed raises its benchmark interest rate, banks eventually raise the rates they offer on savings accounts. When the Fed cuts rates, banks cut their rates too—sometimes immediately, sometimes after a delay. The Fed's rate does not directly determine what your bank pays, but it sets the floor and ceiling for what is possible in the market.

Competition matters. If one bank raises its rate to attract deposits, others follow. If deposits are plentiful and the bank does not need more money, it may lower the rate. This is why the same account type can pay 0.50% at one bank and 4.50% at another. Shopping around for the highest rate can mean hundreds of dollars more per year on the same balance.

Money market accounts and certificates of deposit pay differently

A money market account is a hybrid between a savings account and a checking account. It usually pays a higher APY than a regular savings account, but you get a debit card and limited check-writing. The interest calculation is the same—APY times balance—but the rate is often higher because the bank is asking you to keep a larger minimum balance or accept limited withdrawals.

A certificate of deposit (CD) works differently. You agree to leave your money in the account for a set period—3 months, 6 months, 1 year, 5 years—and in exchange, the bank locks in a higher rate. A 1-year CD might pay 5.0% APY while a regular savings account pays 4.5%. The tradeoff is that you cannot touch the money without paying a penalty, usually equal to a few months of interest.

With a CD, the interest calculation is the same, but you know exactly what you will earn because the rate does not change. If you open a 1-year CD with $10,000 at 5.0% APY, you will have $10,500 at the end of the year (minus any taxes owed). With a regular savings account, the bank could lower the rate after three months, so your actual earnings might be less.

Interest is taxed as income

Every dollar of interest you earn is taxable income. If you earn $500 in interest during the year, you owe federal income tax on that $500 at your ordinary income tax rate. If you are in the 22% tax bracket, you owe $110 in federal tax. Some states also tax interest income, so your state tax bill could be higher.

Banks report interest earnings to the IRS on a Form 1099-INT, which you receive by January 31 each year. You report this on your tax return. If you earn more than $10 in interest during the year, the bank is required to send you the form. If you earn less, the bank may still send it, or you may have to track the interest yourself from your statements.

This is why the real return on your savings is lower than the APY. If you earn 4.5% APY but owe 22% in taxes on that interest, your after-tax return is closer to 3.5%. The higher your tax bracket, the more interest you lose to taxes. This does not change how much interest the bank pays you, but it changes how much you actually keep.

Rates can drop without warning

The APY you see when you open an account is not may provide to stay the same. Banks can lower the rate on your savings account at any time, and they do not need your permission. You will usually get a notice in the mail or an email, but the rate change is not optional. If your bank drops the rate from 4.5% to 3.0%, your earnings drop by a third, and you have no recourse except to move your money to a different bank.

This happens most often when the Federal Reserve cuts interest rates. Banks lower their rates to match the new market conditions. It can also happen when a bank decides it has enough deposits and does not need to attract more customers. Some banks offer a high rate for a promotional period—say, 5.0% for the first three months—then drop it to 2.0% after that.

To protect yourself, check your bank's current rate every few months. If it has dropped significantly and other banks are offering higher rates, moving your money takes about 15 minutes. Most online banks make it easy to transfer funds from your old account, and the interest you earned at the old bank is yours to keep.

High-yield savings accounts earn the most

A high-yield savings account (HYSA) is a regular savings account offered by online banks or online divisions of traditional banks. The only difference is the rate—it is higher because the bank has lower costs. The account works exactly the same way: you deposit money, it earns interest, you can withdraw it anytime (with some limits), and the interest is taxed as income.

High-yield savings accounts currently pay between 4.0% and 5.35% APY, depending on the bank and the current market. A traditional bank savings account might pay 0.01% to 0.50%. On a $50,000 balance, the difference is $2,000 to $2,500 per year in additional interest. Over five years, that is $10,000 to $12,500 more in your account.

The catch is that you need to be comfortable banking online. You cannot walk into a branch and talk to a teller. Most online banks have good customer service by phone and email, but if you prefer in-person banking, you will have to choose between convenience and interest earnings. Some people keep a small amount in a local bank for emergencies and put the bulk of their savings in a high-yield account online.

Frequently Asked Questions

How often does the bank pay interest into my account?

Most banks pay interest monthly, though some pay quarterly or even annually. The frequency does not change how much you earn per year—it just changes when the money shows up in your account. Monthly compounding means you earn interest on your interest 12 times per year instead of 4 times, which adds a tiny boost to your total earnings.

If I withdraw money mid-month, do I lose all the interest I earned that month?

No. Interest is calculated daily, so you earn interest on your balance for each day the money is in the account. If you deposit $10,000 on the first of the month and withdraw $5,000 on the 15th, you earn interest on $10,000 for 14 days and $5,000 for the remaining days. The bank pays you for the exact time your money was there.

What happens to my interest if the bank fails?

Your deposits and all earned interest are protected up to $250,000 per account type per bank by the FDIC (Federal Deposit Insurance Corporation). If the bank fails, the FDIC pays you back in full. This protection covers regular savings accounts, money market accounts, and CDs. Make sure your bank displays the FDIC logo or states it is FDIC-insured.

Can I move my money to a higher-paying bank without losing interest I already earned?

Yes. Interest you have already earned is yours to keep no matter where you move the money. If you earned $200 in interest at Bank A and move to Bank B, you take that $200 with you. Only future interest depends on Bank B's rate. Transfers usually take 3 to 5 business days, and you do not lose interest during the transfer.

Is there a minimum balance to earn interest?

It depends on the bank and account. Some banks pay interest on any balance, even $1. Others require a minimum balance—$500, $1,000, or $10,000—and pay no interest if you fall below it. A few banks pay a lower rate on balances below the minimum. Check your bank's terms before opening an account if the minimum matters to you.