Demystification of Bank Accounts

These days, banks with brick-and-mortar branches are only the start when it comes to your banking options. The banking industry emerged from the internet revolution with new operating trends and new ways to efficiently and easily provide services to customers. Nowadays, you don't even have to step outside your house to create a new bank account.

With more choices though comes more confusion. This article will help you sort through the chaos and gain a better understanding of the types of bank accounts available as well as how each type works.

Types of Accounts

Checking Accounts
The checking account is the simplest and most basic account needed for day-to-day transactions. Electronic transfers and Automated Teller Machine (ATM) transactions have become linked to this type of account as well. In the credit-union world, checking accounts are referred to as share drafts. 

According to federal regulations, there is no limitation on the number of times you can make a deposit or withdrawal in this account type. Since they're used mainly for transaction handling, checking accounts traditionally didn't yield any interest on the balance. However, today many internet banks offer interest yields on their checking accounts.

Checking accounts can be categorized as either personal or business. There can be a lot of differences between these two categories depending on the financial institution, but their underlying function is the same.

Many banks are adding lots of incentives to personal accounts to attract more customers. As a result, some personal checking accounts don't require a monthly minimum balance, don't charge a monthly fee, provide a free ATM/debit card and even offer free checks. Business checking accounts, however, may not have as many freebies. (Read about the service charges that could nickel and dime you right out of your nest egg in The Ins And Outs Of Bank Fees.)

Apart from the fee structure, another important difference is the way the accounts are handled for tax purposes. Personal accounts are opened under your Social Security number (SSN), whereas business accounts use your employer identification number (EIN).

Savings Accounts
Savings accounts are mainly used for saving money. In credit unions, they are called share accounts. All financial institutions may require a minimum amount to open a savings account and a monthly minimum balance, but the amounts vary by institution.

This account pays interest on your balance depending on the federal business interest rate. That means your account's interest rate can go up or down when the Federal Reserve Board (FRB) changes the interest rates. It might not be a direct correlation, but the federal interest rate does have an impact on your savings interest. The interest rate also varies by bank.

All savings accounts, as per Regulation D can only do six transfers per month for each account, whether in person, online, by phone or via automated clearing house (ACH). Savings accounts don't come with checks to do withdrawals. To access your money, you either have to transfer it from savings to checking or withdraw it from an ATM or bank teller. For this reason, many banks recommend that you open a checking account in order to have a savings account.

Savings accounts can also be categorized into personal and business accounts. There is not a major difference between the two except the interest rate they offer and how they are connected to your checking account. However, business savings accounts tend to have bigger minimum balance requirements compared to personal savings accounts.

Many banks and credit unions offer different types of savings accounts, such as vacation savings, education savings and summer savings. All work like ordinary savings; the name tag is different only to help customers save for each purpose. 

Dividend/Interest Checking Accounts

Many banks are coming up with new accounts that combine the essence of checking and savings accounts into one account. Each bank has its own name for this account, such as "platinum checking" or "interest checking." Credit unions call them dividend checking accounts.

The specialty of these accounts is their interest-earning capability. They are similar to ordinary checking accounts, but you have to maintain the monthly minimum balance to either gain interest or avoid monthly charges. They also come with free checks and ATM/debit cards for easy access to funds. 

Money Market Accounts
In the past, money market accounts were meant to be used for any investment or trading purpose. This type of account is specifically meant to be connected to any stock market investment. But nowadays, it's used as another savings vehicle for getting high interest rates compared to savings accounts. Many stock brokerage companies now offer this account whether you plan to invest in stocks or not.

Money market accounts work similarly to savings accounts and can be attached to checking accounts for any transaction. They may have minimum opening balance requirements, depending on the bank. You do get checks to write against these accounts, but you are limited to only three per month, and the institution may require the check to be for a minimum amount, such as $500. Further, money market accounts are limited to six transactions per month total (including ACH and internet transfers) according to federal regulations. (Learn about the easiest way to benefit from money market securities by reading Introduction To Money Market Mutual Funds.)

Certificates of deposit (CDs) allow you to grow your money with high interest rates compared to savings and money market accounts. Credit unions call them share certificates. You need a minimum amount to open a CD, depending on the term and the interest rate being offered. Your money will be locked up in the deposit for the selected length of time, which starts at three months and ranges up to five years or so. You won't be able to withdraw your money without penalty during this period. On maturity, you have a choice to renew the CD with the current rate or withdraw the principal plus interest earned during the deposit period.

You should be able to open CDs in any bank or credit union without opening a checking or savings account. However, many banks offer very attractive high-interest rates on CDs because it is a good way to attract customers and persuade them to open checking accounts.

CDs are a good investment vehicle for the intermediate or long-term. Using a CD-laddering technique, you can help your money grow by taking advantage of compounding. (Educate yourself about this strategy by reading Step Up Your Income With A CD Ladder.)

Account Type: Checking Savings Money Market CD
Purpose: Daily Transactions Saving Short-Term Saving Long-Term Saving
Min. Amount to Open: From $0 to $100 From $0 to $500 From $1,000 From $500
Min. Balance Required: Yes, depends on bank Yes, depends on bank Yes, depends on bank Yes, depends on bank
Checks Available: Yes No Yes, limit of 3 checks per month No
No. of Transactions Allowed: Unlimited 6 per monthly cycle 3 per monthly cycle Only deposits as add-ons
Monthly Charge/Fees: Depends on bank None None Can withdraw with penalty


The Bottom Line

There have been a lot of changes in the banking industry, and you can expect more to come in the future. Every bank or credit union can change their offers or add new account types, which can complicate things and confuse customers. However, if you know the basic categories of accounts and how they work, you should be able to choose the best option for your needs.