Certificates vs. traditional savings accounts: Pros and cons

While watching money build in your checking account is satisfying, it’s not the most efficient way to grow your savings. In most cases, checking accounts offer very low interest rates or even no interest at all. So how can you make your money work harder for you?

Two popular options are certificates and traditional savings accounts. While both offer a way to safely save money and earn interest, there are some major differences you should consider before deciding which one is right for you. Let's take a closer look at the pros and cons of certificates of deposit vs. traditional savings accounts.

Key takeaways

• Certificates can give you better interest rates than traditional savings accounts, but you have to keep your money locked in for a set period.
• Traditional savings accounts allow for more flexibility in accessing your funds but may feature lower interest rates.

What you’ll learn

• What is a certificate and how does one work?
• Pros and cons of certificates
• What is a traditional savings account and how does one work?
• Pros and cons of savings accounts
• When to choose a certificate over a savings account
• When to choose a savings account over a certificate
• Combining certificates and savings accounts in your financial strategy

What is a certificate and how does one work?

A certificate, is a type of savings account offered by credit unions. It is also known as a certificate of deposit (CD) or time deposit when offered by a bank. Certificates typically offer a higher interest rate than traditional savings accounts, but with a catch: You must keep your money in the account for a set period of time, known as the term, which can range from just a few months to several years.

With a certificate, you agree to put down a minimum initial deposit for a specific term, such as six months, one year or five years. Certificate rates are usually fixed, meaning the annual percentage yield (APY) is set when you open the account and won't change until it matures. Generally, the longer the term, the higher the APY you'll receive.

Credit unions and banks base their certificate rates on several factors, including the current interest rate environment, the institution's financial health and competition from other financial institutions. If you take out your money before the certificate matures, you will likely face a penalty fee. This can range from a small percentage of the interest earned to several months’ worth of interest.

Certificates are federally insured up to $250,000 per depositor, per institution, provided they are FDIC-insured (for banks) or carry NCUA insurance (for credit unions).

Pros and cons of certificates

As with any financial product, certificates come with advantages and disadvantages that make them suitable for some but not all investors. Here are the primary pros and cons of certificates to consider.

Pros:

• Higher APYs compared to regular savings accounts.
• Fixed interest rates provide stability and predictability.
• Most certificates don’t come with maintenance fees.
• Helps force you to save by locking in your deposit for a specific period.
• NCUA or FDIC insurance protects your investment.

Cons:

• Withdrawal penalties apply if you withdraw funds early, which can reduce earnings or even consume principal.
• Fixed interest rates mean you may miss out on potential earnings if market interest rates rise.
• Not a liquid asset, meaning it’s not easy to access funds before the certificate term ends.
• Many certificates require a minimum deposit amount between $500 and $2,000, which can be a barrier for some investors.

What is a traditional savings account and how does one work?

A traditional savings account is a bank account that allows you to deposit your money, keep it safe and withdraw funds as needed, all while earning a bit of interest on your balance. These accounts are great for money you don’t need for daily expenses and can be handy for saving up for short-term goals or emergencies.

It's important to note the difference between traditional savings accounts and high-yield savings accounts. High-yield savings accounts offer much higher APYs but could require a larger minimum deposit or balance. In some cases, high-yield accounts might also come with monthly maintenance fees. For example, Alliant’s high-rate savings account requires a $100 daily average minimum balance to earn interest and charges no monthly fee if you elect eStatements.

Savings accounts come with variable interest rates, meaning the rate can change over time based on market conditions. The credit union or bank pays interest on your account balance, usually calculated daily and paid monthly. The great thing about savings accounts is their flexibility—they allow easy deposits and withdrawals, making them handy for everyday use and emergencies.

Regulation D, a former rule by the Federal Reserve Board, used to limit savings account transfers and withdrawals to six per month. This rule was suspended during the COVID-19 pandemic and remains suspended indefinitely. Some banks now allow unlimited withdrawals, but many still charge a fee if you exceed a predetermined limit.

Much like certificates, the interest rates for traditional savings accounts are influenced by the bank or credit union’s need for deposits, competition from other banks and the federal funds rate.

Pros and cons of savings accounts

Known for their straightforward and simple structure, savings accounts are many people's first experience with earning real interest on their money. Let's look at where they stand out as well as where they fall short.

Pros:

• Savings accounts provide immediate access to your money without penalties.
• These accounts allow frequent deposits and withdrawals, offering flexibility.
• No commitment period means your money isn't tied up, allowing you to make changes as needed.
• Most savings accounts have low or no minimum balance requirements, making them accessible.
• NCUA or FDIC insurance covers up to $250,000 per depositor, per insured bank.

Cons:

• Savings accounts generally offer lower interest rates compared to certificates.
• Interest rates can change anytime, so there’s no guarantee of a steady return.
• Some banks charge monthly maintenance fees or require a minimum balance to avoid fees.
• Some savings accounts have monthly withdrawal limits, with fees for excess transactions.

When to choose a certificate over a savings account

Certificates are ideal for long-term financial goals where higher interest rates are more important than immediate access to funds. If you are saving for a significant future expense, such as a down payment on a house or a major life event like a wedding, the fixed term and interest rate of a certificate can help your savings grow more effectively.

Certificates can also be beneficial if you tend to spend money impulsively. The penalty for early withdrawal discourages tapping into your savings prematurely, making it easier to stick to your financial plan. For those prioritizing interest earnings over liquidity, certificates typically offer better rates than traditional savings accounts, providing a more lucrative return on your investment.

When to choose a savings account over a certificate

Traditional savings accounts are better for situations needing flexibility and quick access. They're great for building an emergency fund, as you can get to your money without penalties.

Savings accounts also work well for short-term goals, like saving for a vacation or a minor home renovation, where you anticipate needing the funds within a few months. If you need to maintain easy access to your money for regular expenses or unforeseen circumstances, a savings account provides the necessary flexibility, allowing deposits and withdrawals with no or limited restrictions.

Combining certificates and savings accounts in your financial strategy

A well-rounded financial plan often includes both certificates and savings accounts to meet different needs and goals. You can benefit from the higher interest rates of certificates for long-term savings while keeping some funds in a savings account for immediate or short-term needs.

Certificate laddering is another commonly used strategy. With certificate laddering, you invest in certificates with varying maturity dates, thereby gaining access to liquidity and taking advantage of potentially higher interest rates over time. Start by splitting your investment across several certificates with staggered terms. As the shortest-term certificate matures, reinvest the proceeds into a new, longer-term certificate to keep the ladder going. This approach caters to both immediate cash needs and your overall savings plan.

Choosing between a certificate and a regular savings account is about balancing your need for easy access to your money with the desire for higher returns. While certificates reward patience with better interest rates, savings accounts offer the flexibility to access funds anytime. Consider your financial goals and how quickly you might need your money to make the best choice for your situation. If you have a significant amount of savings, it may make sense to divide your funds between certificates and savings accounts or ladder your certificates for a healthy mix of returns and accessibility.