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High-yield savings accounts: What’s the catch?

Explore how high-yield savings accounts work and whether they’re too good to be true.

A shocking 78% of Americans don’t have a high-yield savings account and while the reasons range from not finding the time to make the switch to not wanting an online bank, many cite a lack of knowledge about how high-yield savings accounts work as their primary reason, according to Finder’s Consumer Confidence Index.

Graphic source

Demystifying high-yield accounts

High-yield savings accounts aren’t so different from traditional savings accounts. They work the same but with two major differences:

  1. They offer stronger APYs.
  2. They’re often offered by online banks.

For a savings account to be considered a high-yield account, it must earn an interest rate higher than the national average, which currently sits at 0.46%, according to the FDIC.

Today, you’ll find high-yield savings accounts well above 5% APY. To compare, most traditional savings accounts still offer rates as low as 0.01% APY.

If you’re looking for a high-yield account, your best bet is to look at online banks, which don’t have the same overhead costs as brick-and-mortar banks. With a lack of operating expenses like rent and utilities, digital banks can pass these savings on to you through lower fees and better rates.

How do they work?

When I’ve talked about high-yield savings accounts with family and friends, I’ve noticed they frequently mistake them for certificates of deposit (CDs). Three questions I’m often asked include:

  1. How often does interest accrue?
  2. Do I have to keep my money locked away before I start earning interest?
  3. What if I need to withdraw my money? Is there a card? And is there a penalty?

So, let’s dig into these a bit closer.

1. Interest accrual

Savings accounts can compound interest daily, monthly, quarterly or annually. Although the frequency depends on the account, they’re often compounded daily and paid monthly.

2. Requirements to earn interest

Not all high-yield savings accounts are the same, but the best ones don’t have any requirements. Some accounts might require a deposit to start earning interest or maintain a balance to earn the highest rate. But many strong accounts offered by online banks don’t have a tiered balance requirement, and if they have a deposit balance requirement, it’s often as low as $1.

Unlike CDs, you don’t have to lock your money away to withdraw your interest and balance. However, to take full advantage of earning interest, you’ll want to deposit money into the account.

While a high-yield savings account with no opening deposit or balance requirements is ideal, an account without money won’t accrue any interest. Also, if you keep a low balance in your account, you’re not taking full advantage of the high APY.

So, if you open a high-yield account, remember to deposit enough to make it worthwhile and start accruing interest right away.

3. Withdrawals and penalties

Most traditional and high-yield savings accounts don’t come with a card. But those that do typically come in the form of an ATM card. You can only use these cards to withdraw money at an ATM, not to make purchases. To make purchases with a savings account, look at opening a money market savings account.

Using an ATM card linked to a savings account is subject to withdrawal limitations if the bank has one. But while savings accounts might have a withdrawal penalty, it’s certainly not to the same extent as with a CD.

Regulation D, a rule under the Securities Act, required banks to limit the number of withdrawals they allow customers to make each month. This applied to savings and money market savings accounts.

During the pandemic, the Federal Reserve suspended the rule, allowing banks to lift their six monthly withdrawal limit. While some banks lifted it, others are still enforcing it. As long as you’re not withdrawing your money more than six times a month, you shouldn’t see any withdrawal fees.

Are there tax implications?

Like a traditional savings account, interest earned with a high-yield savings account is taxable. While you don’t need to report your entire savings balance, you’ll need to report the interest you earned according to your income tax bracket.

If you’ve been keeping your money in a regular savings account, you would have already been reporting this, so it wouldn’t be a new task to learn if you were to open a high-yield account.

What’s the catch?

While it might sound too good to be true, it honestly is. High-yield savings accounts are similar to regular savings accounts. They fall under the same withdrawal requirements, and the same tax implications apply. The major differences are that high-yield savings accounts are often offered by online banks and come with a stronger APY.

Traditional and high-yield savings accounts are both considered low-risk investments. There’s only one minor catch: Unlike CDs, which lock your rate for a specific period, savings accounts have variable rates. This means your rate is at risk of fluctuating over time.

If you want to maintain your savings rate, consider opening a CD. But you also shouldn’t tie up all your savings in a CD. You’ll still want to keep some money in a high-yield savings account so you can access your money in an emergency.

About the Author

Alexa Serrano Cruz is a personal finance editor at Finder, specializing in consumer and business banking. She has worked with publishers and magazines in New York City and Miami. She has extensive experience editing articles, helping readers make informed decisions on their money.

Alexa is a certified anti-money laundering specialist, and her editorial and personal financing expertise has been featured in top publications, including Nasdaq, Best Company, U.S. News & World Report, MSN, Yahoo and ValueWalk. She has also made appearances on Winnie Sun TV, money podcasts such as LifeBlood and broadcast news publications like Fox News and NBC News.

Alexa holds a bachelor’s degree in English from Wesleyan College and enjoys reading memoirs in her spare time.

Image: Getty

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