All the Different Savings Accounts You Need
You have basic checking and savings accounts—besides that, how can different types of accounts serve your savings goals? What’s the smartest way to hide your hard-earned funds? We previously recommended splitting your money into multiple accounts so that you can see all of your savings goals individually to make them easier to track. Money set aside for contingencies goes into an account other than your dream vacation fund, and so on.
Of course, if you live paycheck to paycheck, you may be hesitant to split your savings into multiple accounts. However, a tough economy is exactly the time when accumulating your savings should be a priority. It’s important to understand the basics of all the options available to you, depending on how much you can afford to save right now. So, whether you’re a lifelong saver or getting extra money for the first time, here are the different types of savings you should consider in order to meet your goals.
emergency fund
Unlike your other savings, an emergency fund is a cash reserve reserved solely for unplanned expenses or financial hardship, such as job loss, medical emergencies, or sudden emergency repairs to your car or home.
A typical rule of thumb is to aim for six months of living expenses in your emergency fund. However, as we recently discussed, you can upgrade your emergency fund to include nine months of hidden income.
When you determine the right number for you, consider expenses such as housing, food, utilities, insurance, transportation, and debt payments. Non-essential expenses such as vacations, entertainment or dining do not count towards your “emergency” bill.
Retirement accounts
After you build your emergency fund, you need to make sure you save for retirement . The two main vehicles to start with are the IRA and the 401(k).
There are two main types of IRAs: Traditional and Roth. Simply put, with Roth IRAs, you are paying taxes on your savings right now. With traditional IRAs, you pay taxes later. We’ve written about the differences in more detail here , and we tend to lean towards Pro-Roth over traditional.
A 401(k) is a retirement savings account offered by your employer with significant tax benefits. With a 401(k), the money you save is not only saved but also invested. You have the option to invest in various assets such as stocks, bonds and mutual funds. Your funds are tax-free until you withdraw them, ideally after years of growth. If your workplace offers a 401(k) , aim to contribute between 10% and 20% of your salary.
Here are our guides to opening an IRA and opening a 401(k) .
High Yield Savings Account
When you’re ready to start saving a few years in advance, but certainly before you retire, you might be interested in a high-yielding savings account. Even when the interest rates in your savings account are low (and they are rising now), a high-yield savings account is a smart way to make some profit on the funds you know will be available in the next one to five years.
Think of it this way: if you invest $500 in a mediocre savings account, you will earn $0.50 in interest in one year. With a high yield account with 2% APR, you will earn $10 on that $500, and the more time and money, the more interest.
Here is our guide to choosing a high yield savings account .
Best Alternatives to High Yield Savings Accounts
If you are interested in earning higher interest rates than on a regular or even high yield savings account, your main options are money market accounts and certificates of deposit.
money market account
A money market account (MMA) is a way to earn higher interest rates than a regular savings account. MMAs are notable for having checking account features such as debit cards and limited check writing rights. However, MMAs are not ideal for people starting out with small savings as they require a higher minimum balance than most savings accounts (typically $5,000 to $10,000).
Deposit certificate
A certificate of deposit (CD) is another way to earn interest on your savings. They differ from traditional savings accounts in that they are time-based and are typically offered for terms ranging from three months to five years. Longer terms mean higher interest rates. However, if you withdraw money from your account before the due date, you will pay a penalty.
The bottom line here is that the highest-paying CDs pay higher interest rates than high-yielding savings accounts or MMAs, but the trade-off is that these funds remain untouched for a fixed period of time. MMAs offer more access to your funds, while CD is the choice for those who don’t need access to their savings for a fixed period.
Special savings accounts
For savers who need accounts tailored to their specific savings goals, there are special savings accounts. You can create an education savings account or a children’s savings account for children under 18 years of age . These accounts may have restrictions on who can open them, allowing you to ensure that the money is set aside for a specific purpose. You can find most of these accounts with banks, credit unions, brokerage houses or investment companies.
If you want to get started with multiple savings accounts, Nerdwallet has a good selection of online banks that you can choose from here .