Interest is how a savings account makes money for you

A savings account makes money through interest—a percentage of your balance that the bank pays you each month or year. The bank lends out the money you deposit to other customers and businesses, then shares a portion of what it earns with you. The more you deposit and the longer you leave it there, the more interest you accumulate.

The amount you earn depends on two things: your account balance and the interest rate the bank offers. A $5,000 balance at 4.5% annual interest earns roughly $225 per year. The same balance at 0.01% earns 50 cents. Interest rates change based on what the Federal Reserve does with national rates, so what your bank pays today may differ in six months.

Interest compounds, meaning you earn money on your interest as well as your original deposit. If your account compounds monthly, you get paid twelve times per year on a growing total. This is why leaving money untouched for longer periods produces noticeably more earnings than moving it around.

Key Takeaways

  • Banks pay interest on savings account balances as a percentage per year, and the rate varies by bank and changes over time.
  • High-yield savings accounts currently pay 4% to 5% annual interest, while traditional bank savings accounts often pay less than 0.5%.
  • Interest compounds monthly or daily at most banks, meaning you earn returns on your accumulated interest, not just your original deposit.
  • You can compare rates across banks online before opening an account, and switching to a higher-rate account can double or triple your yearly earnings on the same balance.

High-yield savings accounts pay significantly more than traditional savings accounts

A high-yield savings account is a savings account offered by banks or credit unions that pays a much higher interest rate than a regular savings account at the same institution. As of early 2024, high-yield accounts at online banks typically pay between 4% and 5% annually, while traditional savings accounts at brick-and-mortar banks often pay 0.01% to 0.5%.

The reason online banks offer higher rates is lower overhead—they have no physical branches, so they spend less on buildings and staff. They pass those savings to customers through better interest rates. Online banks are insured by the Federal Deposit Insurance Corporation (FDIC) the same way traditional banks are, so your money is protected up to $250,000 per account.

The trade-off is that you cannot walk into a branch to deposit cash or speak to someone face-to-face. Most high-yield accounts let you transfer money in and out online or through mobile apps, and some allow check deposits through your phone camera. If you rarely need in-person banking, a high-yield account can earn you hundreds of dollars per year on the same balance you would keep in a traditional account.

How to calculate what your savings will earn

To estimate your yearly interest earnings, multiply your account balance by the annual interest rate. A $10,000 balance at 4.5% annual interest earns roughly $450 per year. At 0.5%, the same balance earns $50.

Most banks compound interest daily or monthly, which means the calculation is slightly more complex in practice—you earn small amounts throughout the year that themselves earn interest. However, for balances under $50,000, the difference between simple math and actual compounding is usually less than a few dollars per year.

Use an online savings calculator if you want precision. Search "savings account interest calculator" and enter your balance, the annual rate, and how many months or years you plan to keep the money. The calculator will show you the exact amount you will have at the end, including compounded interest.

Moving money to a higher-rate account can significantly increase your earnings

If you currently have money in a traditional savings account earning 0.01% to 0.5%, moving that balance to a high-yield account earning 4% to 5% can triple or quadruple your yearly interest without any additional effort on your part. A $20,000 balance earning 0.1% makes $20 per year. The same balance at 4.5% makes $900 per year—a difference of $880.

Switching is straightforward. Open a new high-yield account at an online bank, then transfer your money from your old account to the new one. The transfer typically takes one to three business days. Your old account remains open unless you close it, though you may want to close it to avoid monthly fees if the bank charges them.

Check whether your current bank charges a fee for closing an account early. Most do not, but some require you to keep the account open for a minimum time. If there is a fee, weigh it against how much extra interest you will earn in the first year at the new bank. In most cases, the higher interest rate pays for any early-closure fee within a few months.

Interest rates change, so monitor your account's rate periodically

Banks adjust their interest rates based on decisions made by the Federal Reserve, which sets the national benchmark rate. When the Fed raises rates, banks typically raise what they pay on savings accounts within weeks or months. When the Fed cuts rates, banks cut their savings rates too, sometimes immediately.

Your bank will notify you of rate changes, usually by email or through your online account dashboard. However, you are not locked into a rate—if your bank drops its rate significantly and competitors are offering more, you can move your money to a different bank. There is no penalty for switching, and no limit on how many times you can do it.

Set a reminder to check your account's rate once or twice per year. If it has dropped below 3% and other banks are paying 4% or higher, moving your balance takes less than an hour and can save you hundreds of dollars annually.

Certificates of deposit (CDs) lock in a rate for a set time period

A certificate of deposit (CD) is a savings product where you agree to leave your money in the account for a fixed period—typically three months to five years—in exchange for a may provide interest rate. CDs currently pay between 4.5% and 5.5% annually, depending on the term length and the bank.

The main advantage of a CD is certainty. Your rate will not drop during the term, no matter what the Federal Reserve does. The main disadvantage is that you cannot access your money without a penalty. If you withdraw before the term ends, the bank charges a fee that typically equals several months of interest.

CDs make sense if you have money you know you will not need for a specific period. A one-year CD at 5% earns $500 on a $10,000 deposit. If you need the money after six months, you lose roughly $250 to the early-withdrawal penalty, so you only net $250 in interest—still better than a savings account at 0.5%, but less than you would have earned in a high-yield savings account where you could withdraw anytime.

Money market accounts combine features of savings and checking accounts

A money market account is a hybrid product that pays interest like a savings account but lets you write checks or use a debit card like a checking account. Interest rates on money market accounts are typically between savings accounts and high-yield savings accounts—currently around 2% to 4.5% annually.

Money market accounts often require a higher minimum balance than savings accounts, sometimes $2,500 or more. They may also limit how many times per month you can withdraw or transfer money. If you exceed the limit, the bank charges a fee per transaction.

A money market account is useful if you want to earn interest on money you need to access frequently but do not want to keep in a checking account. However, if you are choosing between a money market account and a high-yield savings account, the savings account usually pays more interest and has fewer restrictions.

Frequently Asked Questions

Do I have to pay taxes on savings account interest?

Yes. Interest earned on a savings account is taxable income. Banks send you a 1099-INT form each January if you earned $10 or more in interest during the previous year. You report this amount on your tax return. The tax you owe depends on your overall income and tax bracket.

What is the difference between APY and APR on a savings account?

APY (annual percentage yield) includes the effect of compounding, while APR (annual percentage rate) does not. Banks are required to show you the APY, which is the number that matters for savings accounts. APR is used mainly for loans and credit cards.

Can I lose money in a savings account?

No, as long as the bank is FDIC-insured. Your balance is protected up to $250,000 per account. You cannot lose money to market changes the way you can with stocks or bonds. The only way your balance shrinks is if you withdraw money or if fees exceed your interest earnings.

How often does interest get added to my account?

Most banks compound and deposit interest monthly or daily. Monthly is more common. You will see the interest appear in your account balance on a specific day each month, usually the last day or the first day of the following month.

Should I keep all my money in a savings account to earn interest?

Savings accounts are best for money you need to access within a few years. If you will not need the money for five or more years, a CD or other long-term investment may earn more. If you need the money within a few months, a savings account is appropriate even though the interest is small.