3 Unexpected Downsides of Popular Savings Accounts
KEY POINTS
- You're not guaranteed your interest rate.
- You may be subject to a minimum balance requirement.
- Your interest income could result in a hefty IRS bill.
It's important to have a fully loaded emergency fund at all times. And the best place to stash your emergency fund is none other than a savings account. That way, you can earn interest on your cash while maintaining access to it at all times. And as long as your bank is FDIC-insured, your principal deposit of up to $250,000 is protected. This means you won't lose money up to that amount even if your bank goes under.
But while savings accounts certainly have their benefits, some of the most popular ones out there might come with their share of drawbacks. Here are a few you should be aware of.
1. Your interest rate could drop without notice
The nice thing about opening a certificate of deposit is that you're guaranteed the interest rate you lock in for the duration of its term. So if you open a 12-month CD with a 5.2% APY, you're earning 5.2% on your money for an entire year, regardless of market conditions.
With a savings account, the amount of interest you earn can fluctuate. Savings account rates tend to rise and fall with the Federal Reserve's benchmark interest rate, the federal funds rate. This year, for example, the Fed is expected to cut rates if inflation continues to slow. So the interest rate you're getting on your savings today may not be the interest rate you're eligible for later in the year.
2. There may be a minimum balance requirement
It's not unusual for banks to impose a minimum balance requirement on a savings account. But that may end up being problematic for you, because if your balance falls below a certain level, you could be charged a fee.
What's more, some banks have a certain balance requirement you need to meet to snag the best APY on your money. The CIT Platinum Savings account, for example, allows you to get started with a deposit as low as $100. But if you want the current top APY, you need a balance of $5,000 or more.
3. You could face a whopping tax bill on your earned interest
A big benefit of keeping money in a savings account is earning interest on your cash. But you should know that interest income is taxed as ordinary income -- meaning, you're taxed at the highest rate that's applicable to you based on your IRS bracket.
Of course, savings account interest is just one of many types of income you might earn that's subject to taxes. And being taxed isn't a reason not to open a savings account, just as you shouldn't turn down a $10,000 raise simply because it might raise your tax bill for the year. However, it's something to be aware of for tax-planning purposes.
See, when you earn money from a job, you usually have taxes taken out of your paycheck as you go. When you earn interest in a savings account, you probably aren't paying estimated taxes on that income month after month or quarter after quarter. So if you happen to earn a lot of interest in your savings account during the year, it could result in you having to write the IRS a check when you file your tax return.
Savings accounts offer a lot of value, but they aren't perfect. Be aware of these downsides so you can plan accordingly. For example, you can get around interest rate fluctuations by locking in a CD. You can get around balance minimums by finding a bank that won't charge a fee for having too little money socked away. And while you can't get out of paying taxes on interest income, you can at least plan for it so it isn't a shock.
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