What Is A Savings Account And How Does It Work

Think of your savings account as the adult version of a piggy bank—it exists to help you achieve financial goals like saving for a vacation or a car. It can also be used as an emergency fund. The best way to use it is to let the funds build and not break into it often.

Unlike your piggy bank, you can earn interest on the money in your savings account. But it typically comes with a transaction limit, meaning you’ll incur a fee if you make more than a certain number of monthly transactions. Moreover, you may have to move funds from your savings to your chequing account to take out cash. Otherwise, you may be charged a fee. These accounts typically include very few transactions, like debits, withdrawals and e-transfers since they’re designed not to be dipped into.

In Canada, you can open a savings account at authorized banks and federal credit unions. The account will be available to you in the same way your chequing account is, but, again, it shouldn’t be used as frequently since it is designed for you to build your funds and work towards your savings goals.

You can fund your savings account in a few ways, depending on the bank, including:

• Direct deposit
• E-transfer
• Automated transfers from another chequing or savings account
• Cash or cheque deposits at the ATM or a branch
• Wire transfers from another bank account
• Mobile cheque deposit

You can also earn interest on the funds in your savings account, which you will receive directly into your account each month. Financial institutions offer different rates and different savings accounts, so do your research to find the best one for you.

Related: Best Savings Accounts In Canada For May 2024

Besides being a convenient tool for helping you save for that special thing, there are other benefits to having a savings account. These include:

• Earning interest on your savings: Your money will make you money without having to do anything. While you’ll have to pay tax on your interest earnings, you’re still generating   passive income by just saving regularly.
• Automating your savings: To help you stay on track to meet your financial goals, you can set up an automatic transfer from your chequing account to your savings account. For example, on every payday, you can have $200 sent straight to savings.
• Keeping your money safe: Savings accounts are risk-free, unlike investing money into stocks or mutual funds. What’s more, savings accounts are covered for up to $100,000 of Canada Deposit Insurance Corporation (CDIC) protection in the unlikely event that your bank fails or goes bankrupt.

There isn’t just one type of savings accounts. Here are the different options for you to choose from, depending on your needs:

Traditional accounts

This is the most standard savings account, and it’s offered at banks and credit unions. Savings accounts at major Canadian banks typically earn less than 2% interest. While these accounts are typically free, they often come with just a few free transactions per month.

High-interest accounts

A high-interest savings account works similarly to a traditional savings account: You have full access to your money, and you earn more interest than in a traditional account—about 2% to 5.5%.

Here’s a tip: Interest rates offered by digital banks are typically higher than those offered by traditional banks, and don’t typically come with fees or minimum account balances.

Accounts for children and students

Kids and students can start making financial goals and saving money with special savings accounts designed just for them. These accounts, offered at select Canadian banks, pay interest on funds and can offer special deals, like savings on top brands with an SPC+ membership. These accounts have age limits: under 12 years old for a kid’s account, and 13 to 24 years old for a student account.

TFSAs

A Tax-Free Savings Account (TFSA) is available to all Canadians who are 18 and older and have a valid social insurance number (SIN). It allows you to save money tax-free, meaning you don’t pay taxes on your contributions or interest earned on that money when it is withdrawn.

TFSAs have a contribution room or limit, which is the maximum amount of funds that you can add to your TFSA each year, as well as a cumulative contribution limit. (In 2024, the annual limit is $7,000, and the cumulative limit from age 18 is $95,000.). Depending on the type of investments you have within your TFSA, you may be able to withdraw any amount at any time.

Ready to open a savings account? You can apply for one in person or online by filling out an application. You’ll need to provide the bank with some basic information, including:

• Your name
• Address and phone number
• Date of birth
• Social Insurance Number (SIN)
• Phone number and email address

If you’re interested in a joint account,the bank will also require the same information for your joint account holder. Once you get a savings account, you can fund it in a few ways: take money from your chequing account and deposit it into your savings, deposit cash into it, or send a wire or electronic money transfer.

The amount of money you keep in your savings account is completely up to you and depends entirely on what you’re using it for. Treating your savings account as your emergency fund? Then it’s a good idea to save at least three months’ worth of living expenses. If you’re using it as a sinking fund for a vacation or an upcoming home renovation, the amount will depend entirely on the cost of your goal.

Once your savings goals are met, you may want to start investing your money. While keeping your money in investments is riskier than keeping it in your savings, you could earn a significantly higher rate of return.

A savings account is not the only place to save for your financial goals. Depending on your needs, one of the following alternatives may be a better option:

• Hybrid accounts: A hybrid bank account acts as a savings account and a chequing account in one. It provides a high interest rate on your funds while offering flexibility with day-to-day transactions. That means you can treat it like a chequing account while having your money make money.
• Prepaid credit cards: Prepaid credit cards help you reach your savings goals by ensuring you spend only money you have so you don’t accrue debt. They’re simple to use: just load any amount on the card, and it can earn interest or be used for day-to-day transactions. You may be able to even earn cash back on your spending.
• Guaranteed Investment Certificate: Guaranteed Investment Certificates  (GICs) are a low-risk option for investing money. They’re available at Canadian banks and trust companies and offer a guaranteed rate of return. But GICs are best used for longer-term saving goals, because they have a fixed time period ranging from a few months to several years.
• Cash management account: Some banks and investment firms offer cash management accounts, which hold money you’re not quite ready to invest but can earn you interest.
• High-yield chequing: With a high-yield chequing account, you can earn interest on the money you set aside for day-to-day expenses. These accounts may require you to meet a certain transactional requirement every month.

As mentioned, a chequing account is used for daily purchases, and a savings account is used for building funds to meet your financial goals. Here’s a breakdown:

Chequing Accounts

• Use for everyday purchases, such as buying groceries or paying bills
• High number of transactions you can perform free of charge per month
• Typically don’t earn any interest on the balance you maintain in your account (except for select accounts)

Savings Accounts

• Earn interest, depending on the bank
• Encourages saving money to meet your financial goals and offers insurance for unexpected expenses
• Comes with limited free transactions, meaning you could incur additional transaction fees
• Not for day-to-day transactions

A savings account helps you organize your finances, save for unexpected expenses and work towards your short- and long-term financial goals. Explore all of your options to determine which savings account is the best option for you.