When you go to a bank to open a new account, you will have a variety of account types and features to choose from. Should you choose the basic checking option or an account that earns interest? Do you want the convenience of a bundled checking and savings account or the higher returns of a money market account?
To make these decisions, it’s helpful to first understand the differences between the most common bank account types. Here are some definitions to help you navigate your banking needs:
- Checking account: A checking account offers easy access to your money for your daily transactional needs and helps keep your cash secure. Customers can typically use a debit card or checks to make purchases or pay bills. Accounts may have different options to help avoid the monthly service fee. To determine the most economical choice, compare the benefits of different checking accounts with the services you actually need.
- Savings account: A savings account allows you to accumulate interest on funds you've saved for future needs. Interest rates can be compounded on a daily, weekly, monthly, or annual basis. Savings accounts vary by monthly service fees, interest rates, and account features. Understanding the account’s terms and benefits will allow for a more informed decision on the account best suited for your needs.
- Certificate of Deposit (CD): Certificates of deposit or CD, allow you to save your money at a set interest rate for a pre-set period of time - which can range from a few months to several years. CDs often have higher interest rates than traditional savings accounts because the money you deposit is tied up for the term of the CD. Be sure you will not need the funds before the end of the CD term, as early withdrawals may have financial penalties.
- Money market account: Money market accounts are similar to savings accounts, but they typically require you to maintain a higher balance to avoid a monthly service fee. Both savings and money market accounts have variable rates. Money market accounts can have tiered interest rates, providing more favorable rates based on higher balances. Some money market accounts also allow you to write checks against your funds, but may be on a more limited basis.
- Individual Retirement Accounts (IRAs): IRAs, or Individual Retirement Accounts, allow you to save independently for your retirement. These plans are useful if your employer doesn’t offer a 401(k) or other qualified employer sponsored retirement plan (QRP), including 403(b) and governmental 457(b), or you want to save more than your employer-sponsored plan allows. These accounts come in two types: the Traditional IRA and Roth IRA. The Roth IRA offers tax-free growth potential. Investment earnings are distributed tax-free in retirement, if the account was funded for more than five years and you are at least age 59½, or you are disabled, or you are using the first-time homebuyer exception, or the payment is made to your beneficiary due to your death. Traditional IRAs offers tax-deferred growth potential. You pay no taxes on any investment earnings until you withdraw or “distribute” the money from your account, presumably in retirement. Both types of IRAs offer investment flexibility, tax advantages, and the same contribution limits. You may want to discuss which type is best for you with your tax advisor before choosing your account.
Once you understand the types of accounts most banks offer, you can begin to determine which option might be right for you.
Tip
Interest rates can be compounded on a daily, weekly, monthly, or annual basis.
Income tax will apply to Traditional IRA distributions that you have to include in gross income. Qualified Roth IRA distributions are not included in gross income. Roth IRA distributions are generally considered “qualified” provided a Roth IRA has been open for more than five years and the owner has reached age 59½ or meets other requirements. Both Traditional and Roth IRA distributions may be subject to an IRS 10% additional tax for early or pre-59 ½ distributions.
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