A savings account is a bank account that pays interest on the money you deposit. Savings accounts are essentially holding accounts; they are not meant to be day-to-day banking accounts.
Financial institutions assume that you will keep money within the account for a while, so they reward you by paying interest on deposits. The more you have in your savings account, and the longer you keep it there, the more interest you will earn.
That said, the current interest rates on the majority of savings accounts are quite low, which means they are best used for short-term goals.
How does a savings account work?
Savings accounts work much in the same way as chequing accounts, but with more restrictions.
You can withdraw or deposit money into them. However, most savings accounts have a limited number of monthly withdrawals. Go over that number and you’ll be charged a fee. Savings accounts may also charge fees for debit card purchases, money transfers, or other transactions. Additionally, savings accounts do not have cheque writing privileges.
Most basic savings accounts are free, but the interest earned is considered taxable income, except when held in registered accounts, such as a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP).
How do I use a savings account?
As mentioned above, savings accounts work very similarly to chequing accounts. You can quickly transfer money in and out of your savings account as needed. Just be aware of any limits that may involve fees. To make things easy, consider setting up an automatic deposit so every time you get paid, a pre-specified amount from your paycheque will be automatically deposited into your savings.
The interest paid on savings accounts makes them best for short-term goals. For example, if you are saving for a vacation or home renovations, then a high-interest savings account is a great place to hold your money until you have enough for the purchase.
Similarly, you will want to keep your emergency fund in a savings account. It can accumulate interest until you need it, but it stays safe and is easily accessible should you suddenly need to dip into it.
For long-term savings, such as retirement, consider investing in an RRSP or TFSA, which can provide better returns over the long haul. As a bonus, you’ll shelter your investment earnings from income taxes.
How is interest paid?
Interest on savings accounts is typically compounded, which means you earn interest on your original deposit (the principal) and any interest you accumulate. So essentially, you earn interest on the interest, which is what you want to make your savings grow faster.
What you need to pay attention to is how often that interest is compounded. It could be yearly, monthly, or even daily. The more frequently interest is compounded, the faster you will earn money.
It is important to note that all savings accounts vary, but some may have minimum deposit requirements to be eligible to earn interest. Additionally, some financial institutions may have tiered interest rates or promotional interest rates that are only valid for a specific amount of time before reducing to a lower rate.
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Types of savings accounts
There are several different types of savings accounts available to Canadians. These are some options to consider:
Basic savings account
Basic savings accounts have been described so far in this article. This type of account allows you to earn a little bit of interest on your deposit but has more limitations than a chequing account.
High-interest savings account (HISA)
HISAs work the same as basic savings accounts, except they offer higher interest. Ideally, this is where you should be parking your money. Keep in mind, HISAs typically come with more rules and limitations than basic savings accounts (i.e.: fewer withdrawals). That said, your funds are still liquid and easily accessible.
Youth Savings Account
Typically, these accounts for young Canadians go to age 18, but there are some exceptions. Accounts are free, have a couple of free monthly transactions, and no minimum balances.
U.S.-dollar Savings Account
USD savings accounts are the same as a basic savings account, but for funds in U.S. dollars.
Tax-Free Savings Account (TFSA)
A TFSA is a registered investment or savings fund for Canadians who are 18 or older. Interest/investment earnings in a TFSA compound without tax and withdrawals are also not taxed.
Registered Retirement Savings Plan (RRSP)
An RRSP is a tax-advantaged account that allows you to save and invest for retirement. Taxes on RRSP contributions and interest/investment earnings are deferred until you withdraw the funds.
How many savings accounts can I have?
There is no limit to the number of savings accounts you can have. In fact, it’s encouraged to have separate savings accounts for each of your goals. These could include emergency savings, retirement savings, savings for a car, savings for a down payment on a home, and a vacation fund. It’s up to you.
» MORE: How to save money the right way
How to get a savings account
You can open a savings account in person at your chosen financial institution or online. You will need to answer some personal questions and know your SIN (social insurance number). If you are opening your account in person, it’s a good idea to bring a couple of pieces of photo identification. You can start using your savings account immediately after opening.
A chequing account is a bank account for everyday expenses. You can have your paycheque deposited directly into it and use it to pay bills, make purchases and withdraw cash.
The Canada Deposit Insurance Corporation (CDIC) may protect your money in the unlikely event that your financial institution fails. The CDIC will cover up to $100,000 per eligible account, per member bank.