What is a High Yield Savings Account?

High-yield savings accounts function like traditional savings accounts. They are usually offered by financial institutions, and money can be stored in them for short- or long-term financial goals. Like traditional savings accounts, the money is easy to access. Also, like traditional savings accounts, monthly withdrawals are limited by the government.

Where a high-yield savings account differs from a traditional savings account is the interest rates. The interest rate is variable, meaning it can go up or down. Currently, traditional savings accounts provide very little interest for deposits. Often, the interest rate is below 1%. High-yield savings accounts typically offer a much higher rate than traditional savings accounts. As of this writing, interest rates in some high-yield savings accounts are approaching 5%. Needless to say, the gap is significant.

While the higher interest rate does not always fully cover inflation, it can reduce inflation’s impact on the money held in a high-yield savings account. The higher interest rate can also increase the power of compounding, making money off your money. Traditional savings accounts do very little to help with compounding.

Banks and other financial institutions can provide higher rates for these accounts for two primary reasons: higher minimum balance requirements and lower overhead. Financial institutions make money off your deposits. Therefore, they will offer rates to customers who will deposit larger amounts of money. This is why high-yield savings accounts typically have a higher minimum balance than traditional savings accounts. It ensures they are enticing customers who can maintain larger balances.

High-yield savings accounts usually have lower overhead due to their online-only presence. This is not to say a person cannot find a high-yield savings account through their traditional bank, but most of these accounts are found with institutions that have a heavy digital, rather than physical, presence.

The FDIC (Federal Deposit Insurance Corporation) insures deposits in member banks up to $250,000 per depositor, per insured bank. This means that your savings would still be protected up to the insured limit if the financial institution were to fail. FDIC insurance should be a significant factor when choosing where to store money. Fortunately, most high-yield savings accounts are insured by the FDIC. However, it is wise to make sure an account is insured before depositing any money into it.

High-yield savings accounts can be a great place to store money for future purposes. But before you deposit money into a high-yield savings account, make sure you know the minimum balance requirements and any restrictions related to the account. You don't want fees to eat away at the potential higher return.