What Is a Savings Account? How Does It Work?

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 and no cheque writing privileges.

You can withdraw or deposit money into a savings account as your funds are liquid. 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.

Most basic savings accounts are free. However, 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?

You can quickly transfer money in and out of your savings account as long as you're aware of the account 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, making your savings grow faster.

What you need to pay attention to is how often that interest is compounds. 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.

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

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)

A high-interest savings account works the same way as a basic savings account, except it offers 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 25, 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)

TFSAs are registered investment or savings funds 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)

RRSPs are tax-advantaged accounts that allow you to save and invest for retirement. Taxes on RRSP contributions and interest/investment earnings are deferred until you withdraw the funds.

First Home Savings Account (FHSA)

Introduced in 2023, the FHSA is a tax-advantaged account that enables first time home buyers to save for a down payment. Like the RRSP, contributions and interest/investment earnings are deferred until you withdraw the funds. There are contribution limits and timelines that you should familiarize yourself with if using this account.