Pros and Cons of Traditional Savings Accounts
In their heyday, traditional savings accounts were as American as apple pie. Typically, savers would wait until they had enough in their accounts to make major purchases. This type of savings account remains among the safest out there, and it still has a place — albeit a less central one — in a modern financial plan.
Pros: Your Money Is Safe
Traditional savings accounts were once beloved because they were the safest place to put your money — and they are still safe. Each account you have is insured up to $250,000 by either the Federal Deposit Insurance Corporation (FDIC) for bank accounts or the National Credit Union Share Insurance Fund (NCUSIF) for credit union accounts. That means that if a bank or credit union fails, the government will step in to replace funds you may have lost.
Pros: The Funds Are Liquid
If you put your money in a Certificate of Deposit (CD) or an IRA account, you may have to pay penalties if you need to withdraw it immediately. Traditional savings accounts are liquid, meaning you can withdraw money today or whenever you need it without paying a financial penalty. Another plus is that the amount in a traditional savings account goes down only when you make withdrawals. Compare this to most investment accounts, where the values go up and down due to market fluctuations. In these accounts, you may no longer have the money you thought you did when the need for it arises.
Cons: Low Yield
Safety and liquidity in savings accounts come at a steep price: traditional savings accounts offer a paltry amount of interest compared to other types of accounts. They are one of the least rewarding ways to save money, earning interest rates between 1 percent and 2 percent per year. Rates vary from state to state and bank to bank, so check around before you commit your money. Whatever interest rate you get, it will be considerably less than the return you can get on other types of accounts.
Cons: No Tax Savings
The money you deposit into a traditional savings account is money you've already paid income tax on. Plus, you'll have to pay the full tax rate on any interest you earn. These features do not compare well to investment options such as IRAs, Keogh accounts and other tax-deferred vehicles. Given the low interest and the lack of a tax advantage, you may want to reserve a traditional savings account for your emergency funds. That's where safety and liquidity counts most.