Making Sense of Savings*

What do you do with your money?

You have many choices concerning what you do with your money--spend it, invest it, or hide it under your mattress. If you invest or save your money, you have many alternatives. For example, you can buy U.S. savings bonds or Treasury bills; purchase stocks or bonds; invest in a mutual fund; or open a savings or other deposit account with a bank, savings and loan association, savings bank, or credit union. This document will help you understand your choices if you decide to put money in an account at a depository institution such as a bank or savings and loan association.

Opening an account is like buying a car. Many products are available--some more expensive than others. Because features of accounts and costs can vary greatly, it is important to shop around to make sure the account you choose is the best one for you.

Do you need a bank account?

There are many reasons for opening a bank account. First, an account may help you save money --since it is often easier not to touch your savings if you keep them in a bank or other institution. Second, an account may be a less expensive way to manage your money than are other alternatives. Buying money orders to pay your bills or paying a business to cash your paycheck may end up costing you a lot more than keeping an account would. Third, having your money in an account is safer than holding cash. Finally, keeping track of your money and how you spend it may be easier.

What types of deposit accounts are available?

Depository institutions may offer a great variety of accounts, but they generally fall within one of these four types:

1. Checking Accounts

With a checking account you use checks to withdraw money from the account that you have deposited in it. Thus you have quick, convenient--and, if needed, frequent--access to your money. Typically, you can make deposits into the account as often as you choose. Many institutions will enable you to withdraw or deposit funds at an automated teller machine (ATM) or to pay for purchases at stores with your ATM card.

Some checking accounts pay interest; others do not. A regular checking account (frequently called a demand deposit account) does not pay interest; a negotiable order of withdrawal (NOW) account does.

Institutions may impose fees on checking accounts, besides a charge for the checks you order. Fees vary among institutions. Some institutions charge a maintenance or flat monthly fee regardless of the balance in your account. Other institutions charge a monthly fee if the minimum balance in your account drops below a certain amount. Some charge a fee for every transaction, such as for each check you write or for each withdrawal you make at an ATM. Many institutions impose a combination of these fees.

Although a checking account that pays interest may appear more attractive than one that does not, it is important to look at fees for both types of accounts. Often checking accounts that pay interest charge higher fees than do regular checking accounts, so you could end up paying more in fees than you earn in interest.

2. Money Market Deposit Accounts

Most institutions offer an interest-bearing account that allows you to write checks, called a money market deposit account (MMDA). This type of account usually pays a higher rate of interest than a checking or savings account. MMDAs often require a minimum balance but they frequently pay higher rates. Withdrawing funds from an MMDA may not be as convenient as doing so from a checking account. Each month, you are limited to six transfers to another account or to other people, and only three of these transfers can be by check. As they do with checking accounts, most institutions impose fees on MMDAs.

3. Savings Account

With savings accounts you can make withdrawals, but you do not have the flexibility of using checks to do so. As with an MMDA, the number of withdrawals or transfers you can make on the account each month is limited.

Many institutions offer more than one type of savings account--for example, passbook savings and statement savings. With a passbook savings account you receive a record book--called a passbook--in which your deposits and withdrawals are entered to keep track of transactions on your account; this passbook must be presented when you make deposits and withdrawals. With a statement savings account, the institution regularly mails you a statement that shows your withdrawals and deposits for the account.

As with other accounts, institutions may assess various fees on savings accounts, such as minimum balance fees.

Credit Union Accounts

Credit unions offer accounts that are similar to accounts at other depository institutions, but have different names. Credit union members have share draft (rather than checking) accounts, share (rather than savings) accounts, and share certificate (rather than certificate of deposit) accounts.

4. Time Deposits (Certificates of Deposit)

Time deposits are often called certificates of deposits, or CD's. They usually offer a guaranteed rate of interest for a specified term, such as one year. Institutions offer CDs that allow you to choose the length of time, or term, that your money is on deposit. Terms can range from several days to several years. Once you have chosen the term you want, the institution will generally require that you keep your money in the account until the term ends, that is, until maturity. Some institutions will allow you to withdraw the interest you earn even though you may not be permitted to take out any of your initial deposit (the principal). Because you agree to leave your funds for a specified period, the institution may pay you a higher rate of interest than it would for a savings or other account. Typically, the longer term, the higher the annual percentage yield.

Sometimes an institution allows you to withdraw your principal funds before maturity, but a penalty is frequently charged. Penalties vary among institutions, and they can be hefty. The penalty could be greater than the amount of interest earned, so you could lose some of our principal deposit.

Institutions will notify you before the maturity date for most CDs. Often CDs renew automatically. Therefore, if you do not notify the institution at maturity that you wish to withdraw your money, the CD will roll over, or continue, for another term.

Basic or No Frill Banking Accounts

Many institutions offer accounts (often referred to as basic or no frill accounts) that provide you with a limited set of services for a low price. Basic accounts give you a convenient way to pay bills and cash checks for less than you might pay without an account. They are usually checking accounts, but they may limit the number of deposits and withdrawals you can make. Interest generally is not paid on basic accounts. Compare basic and regular checking accounts for the best deal in low fees or low minimum balance requirements.

What type of account is right for you?

What type of account should you open? The answer depends on how you plan to use the account. If you want to build up your savings and you think that you will not need your money soon, a certificate of deposit may be right for you.

If you need to use your money, however, a savings or checking account may be a better choice. You will probably find that a checking account is best for you if you plan to write several checks each month (for example, to pay bills). But if you usually write only two or three checks each month, then an MMDA might be a better deal. MMDAs usually pay a higher rate of interest than do checking accounts, but minimum balance requirements are often higher as well.

Remember, account features and fees vary from one institution to the next. If you have questions, you should ask a representative of the institution about any account features and fees BEFORE you open an account.

Account features to compare

In shopping for an account, it is important to look closely and compare features. Here are some of the most common features to compare:

Rates

The Interest Rate

• What is the interest rate?
• Can the institution change the rate after you open the account?
• Does the institution pay different levels of interest depending on the amount of your account balance and, if so, in what way is interest calculated?

Interest Compounding

• How often is interest compounded? In other words, when does the institution start paying interest on the interest you've already earned in the account?

The Annual Percentage Yield (APY) The APY is a rate that reflects the amount of interest you will earn on a deposit.

• What is the minimum balance required before you begin earning interest?

When You Start Earning Interest

• Do you begin earning interest on the day you deposit a check into your account--called earning on your ledger balance; or
• Do you begin earning interest later, when the institution receives credit for the check--known as earning on your collected balance?

Different Rates for Different Balances?

Tiered Rates

Institutions may pay different tiered rates that are tied to different balance amounts.

For example, an institution may pay a 5 percent interest rate on balances up to $5,000 and 5.5 percent on balances above $5,000. If you deposit $8,000, the institution that pays interest on the entire balance pays you 5.5 percent on the entire$8,000. Other institutions may pay you 5 percent on the first $5,000 and 5.5 percent only on the remaining $3,000.

To tell which method an institution uses, check the annual percentage yield (APY) disclosure. If it is a single figure for a balance level, you will be paid the stated interest rate for the entire balance. If the APY is stated as a range for each balance level, your earnings will depend on the balance you keep in each level. Of course, getting paid the stated interest rate on the entire balance is a better deal.

Fees

• Will you pay a flat monthly fee?
• Will you pay a fee if the balance in your account drops below a specified amount?
• Is there a charge for each deposit and withdrawal you make?
• If you can use ATMs to make deposits and withdrawals on your account, is there a charge for this service? Does it matter whether the transaction takes place at an ATM owned by the institution?
• If you have a checking account or an MMDA, how much will ordering checks cost? Will you be charged for each check you write?
• Are fees reduced if you have other accounts at the institution?
• Are fees reduced or waived if you agree to directly deposit your paycheck or government payments, like a social security check?
• What is the fee if you request the institution to stop payment on a check you have written?
• Is there a charge for asking how much money you have in your account (balance inquiry)?
• Does the institution charge a fee for closing an account soon after it is opened? If it does, when will the fee be imposed?
• What is the charge for writing a check that bounces (a check returned for insufficient funds)? And what happens if you deposit a check written by another person, and it bounces? Are you charged a fee?

Other Features

• Does the institution limit the number or the dollar amount of withdrawals or deposits you make?
• If you close the account before interest is credited to your account will the institution pay you the interest that has been earned until that time?
• How soon does the institution allow you to withdraw funds that you have deposited to your account?

Time Deposits

• What is the term of the account? In other words, when does it mature?
• Will the account roll over automatically? In other words, does the account renew unless you withdraw your money at maturity or during any grace period provided after maturity? A grace period is the time after maturity when you can withdraw your money without penalty. If there is a grace period, how long is it?
• If you are allowed to withdraw your money before maturity, will the institution impose a penalty? If so, how much?
• Will the institution regularly send you the amount of interest you are earning on your account--or regularly credit it to another account of yours, like a savings account?

Information Required from Institutions

The Truth in Savings Act, a federal law, requires depository institutions to provide you with--or disclose to you--the important terms of their consumer deposit accounts. Institutions must tell you:

• The annual percentage yield and interest rate;
• Cost information, such as fees that may be charged; and
• Information about other features such as any minimum balance amount required to earn interest or to avoid fees.

To help you shop for the best accounts, an institution must give you information about any consumer deposit account the institution offers, if you ask for it. You also will usually get disclosures before you actually open an account.

In addition, the Truth in Savings Act generally requires that interest and fee information be provided on any periodic statements sent to you. And if you have a roll-over CD that is longer than one month, the law requires also that you get a renewal notice before the CD matures.

Federal Deposit Insurance

Federal deposit insurance sets apart deposit accounts from other savings choices. Only deposit accounts at federally insured depository institutions are protected by federal deposit insurance. Generally, the government protects the money you have on deposit to a limit of $100,000. Accounts for special relationships, such as trusts or co-owners, may also have some effect on the amount of insurance coverage you have. Asking how the deposit insurance rules will apply to your deposit accounts is always a good idea.

Federally insured depository institutions also offer products that are not protected by insurance. For example, you may purchase shares in a mutual fund or an annuity. These investments are not protected by the federal government.

Glossary

Annual Percentage Yield The amount of interest you will earn on a deposit on a yearly basis expressed as a percentage.

Compounding Interest The frequency that earned interest is added to the principal so that you begin to earn interest on that amount as well as on the principal. Often referred to as interest on interest. The more often interest is compounded, the greater the annual percentage yield.

Crediting Interest When you have access to the interest. Usually, posting the interest you have earned to your account.

Grace Period The period after an automatically renewing time deposit, such as a certificate of deposit, matures. During this time you may withdraw funds without being charged a penalty.

Interest Rate The rate of interest, expressed as a percentage, that an account will earn if funds are kept on deposit for a full year. It does not reflect the effect of compounding interest.

Tiered Rates An interest rate structure by which the rate paid on an account is tied to a specified balance level.

Time Deposit An account, such as a certificate of deposit, with a maturity of at least seven days, from which you are not generally allowed to withdraw funds unless you pay a penalty.

Source: Board of Governors of the Federal Reserve System

* Courtesy of The Federal Reserve Board