Interest is money your bank pays you for keeping money in your account

When you deposit money into a savings account, the bank lends that money to other customers through mortgages, car loans, and business loans. The bank keeps the difference between what it pays you and what it charges borrowers. That payment to you is interest—usually expressed as an annual percentage rate, or APR.

The amount you earn depends on three things: how much money sits in your account, what interest rate the bank offers, and how long the money stays there. A $5,000 balance at 4.5% APR earns roughly $225 per year. The same balance at 0.01% APR earns 50 cents. The difference between a high-yield account and a traditional bank account can be hundreds of dollars per year on the same deposit.

Interest compounds, meaning you earn interest on your interest. If your account compounds daily, the bank calculates and adds interest every single day, and tomorrow's interest calculation includes today's interest. Monthly compounding is more common at traditional banks. The more frequently interest compounds, the more you earn overall.

Key Takeaways

  • Banks currently offer savings rates ranging from 0.01% to over 5% APR depending on the institution, with online banks typically offering higher rates than brick-and-mortar branches.
  • Interest compounds at different frequencies—daily, monthly, or quarterly—and more frequent compounding means you earn slightly more on the same balance and rate.
  • High-yield savings accounts at online banks often pay 10 to 50 times more interest than traditional bank savings accounts on identical deposits.
  • Your interest earnings appear as deposits in your account and are taxable income, so you will receive a 1099-INT form from your bank if you earn $10 or more in a year.
  • Moving money between accounts or closing an account does not affect interest you have already earned, but it stops future interest from accruing on that balance.

Where interest rates differ most: online banks versus traditional banks

Online banks—institutions with no physical branches—consistently offer higher interest rates than traditional banks. As of early 2024, many online banks pay between 4% and 5.35% APR on savings accounts, while most brick-and-mortar banks pay 0.01% to 0.05%. The reason is straightforward: online banks have lower overhead costs because they do not maintain branch buildings or employ tellers.

A $10,000 deposit at a traditional bank paying 0.02% APR earns $2 per year. The same deposit at an online bank paying 4.5% APR earns $450 per year—a difference of $448 on money that sits untouched. Over five years, that gap grows to more than $2,300 because of compounding.

Online banks are FDIC-insured just like traditional banks, meaning your deposits are protected up to $250,000 per account holder per institution. The trade-off is that you cannot walk into a branch to deposit cash or speak to someone in person, though most online banks let you deposit checks by phone camera and offer customer service by phone or chat.

How to compare rates and find the account that pays you the most

Interest rates change constantly. A bank offering 5% one month may drop to 4.75% the next. Before opening an account, check the current rate on the bank's website—the rate advertised in an email or ad may be outdated. Look specifically for the APY (annual percentage yield), which includes the effect of compounding and is more accurate than APR for comparison.

Compare at least three institutions. A spreadsheet with columns for bank name, current APY, compounding frequency, minimum balance requirements, and monthly fees takes five minutes to build and shows you exactly which account earns the most. Some banks offer higher rates only on balances above $25,000 or require direct deposit to may have access to, so read the terms before you open.

Websites like Bankrate, DepositAccounts, and the Federal Reserve's National Information Center list current rates at hundreds of banks and credit unions. These sites update daily and let you sort by rate, so you can see which institutions are paying the highest APY right now. Credit unions sometimes offer competitive rates and may have lower fees than banks, though they typically require membership.

What happens to your interest if you withdraw money early

Interest you have already earned stays in your account—withdrawing money does not erase past interest. If you earned $50 in interest over three months and then withdraw half your balance, you keep the $50. Future interest, however, is calculated only on the remaining balance.

Some savings accounts have no withdrawal limits or penalties. Others, particularly those marketed as "high-yield" or "money market" accounts, may restrict how many withdrawals you can make per month without a fee. Federal rules previously capped savings account withdrawals at six per month, but that rule was suspended in 2020 and most banks have not reinstated it. Check your account's terms to see whether withdrawals carry fees or restrictions.

If you need the money in less than a year, a high-yield savings account still beats a checking account (which usually pays no interest) or keeping cash at home. Even at 4.5% APY, money you withdraw after six months has earned interest for those six months and will not earn interest after you withdraw it.

How interest is taxed and what forms you will receive

Interest income is taxable. The bank reports your earnings to the IRS on a 1099-INT form, which you receive by January 31 of the following year if you earned $10 or more in interest during the previous year. You report this income on your tax return, and it is taxed at your ordinary income tax rate—the same rate as wages or salary.

If you earned $100 in interest and your tax bracket is 22%, you owe roughly $22 in federal tax on that interest. Some states also tax interest income. The bank does not withhold this tax automatically unless you request it, so you may owe money when you file your return. Many people set aside a portion of their interest earnings to cover taxes, or they adjust their withholding on their W-4 form if they have a job.

Interest earned in a traditional IRA, Roth IRA, or 401(k) is not taxed in the year it is earned—you pay taxes when you withdraw the money in retirement (or never, in the case of a Roth). If you have a large savings balance, opening a high-yield savings account inside an IRA can reduce your tax burden, though IRAs have annual contribution limits and withdrawal rules.

Why some accounts offer promotional rates and how long they last

Banks sometimes advertise unusually high rates for new customers—5.5% or 6% APY—for a limited time. These promotional rates typically last three to six months, after which the rate drops to the bank's standard rate. Read the fine print to see when the promotional period ends and what the regular rate will be.

Promotional rates are real money. If a bank offers 5.5% for six months on a $25,000 deposit, you earn roughly $687 in interest during that period. After the promotion ends and the rate drops to 4.5%, you earn less on the same balance. Some people move their money between banks to chase promotional rates, opening a new account every few months. This strategy works if you are willing to manage multiple accounts and track when rates change, but it requires attention.

Not all banks offer promotions. Some maintain competitive standard rates year-round instead of using promotional rates to attract new customers. If you find a bank with a consistently high standard rate and no promotional gimmicks, it may be a better long-term choice than chasing promotions.

The difference between savings accounts, money market accounts, and CDs

A savings account lets you deposit and withdraw money whenever you want, with interest paid on your balance. A money market account is similar but often requires a higher minimum balance and may offer a slightly higher rate in exchange. Both are liquid, meaning you can access your money when ready.

A certificate of deposit (CD) locks your money away for a set period—three months, one year, five years—in exchange for a higher interest rate. If you withdraw before the term ends, you pay a penalty, usually equal to a few months of interest. CDs make sense if you know you will not need the money for a specific period and want to lock in a higher rate. Savings accounts make sense if you might need the money sooner.

Current rates vary by product and bank. A one-year CD might pay 5.25% while a savings account at the same bank pays 4.75%. The extra 0.5% is the bank's way of rewarding you for agreeing not to touch the money. If interest rates drop after you open a CD, you are locked into the higher rate. If rates rise, you are stuck with the lower rate until the CD matures.

Frequently Asked Questions

How often does interest get added to my account?

Compounding frequency varies by bank. Most online banks compound daily, meaning interest is calculated and added every day. Some banks compound monthly or quarterly. Daily compounding earns you slightly more over time because you earn interest on interest more frequently. Check your account disclosure or call the bank to confirm how often interest is added.

Can I lose money if interest rates drop?

No. Interest rates dropping means the bank will pay you less interest on new deposits or when your promotional rate ends, but you do not lose money you have already earned. Your balance stays the same. If you want to lock in a higher rate before it drops, consider a CD, which guarantees the rate for the full term.

Is my interest earnings safe if the bank fails?

Yes. FDIC insurance covers both your principal balance and any interest you have earned, up to $250,000 total per account holder per bank. If a bank fails, the FDIC pays you the full amount, including interest accrued through the failure date. Online banks are FDIC-insured just like traditional banks.

What is the difference between APR and APY?

APR is the annual percentage rate without accounting for compounding. APY is the annual percentage yield and includes the effect of compounding. APY is always equal to or higher than APR on a savings account. When comparing accounts, use APY because it shows the actual amount you will earn.

Do I have to report interest earnings under $10?

The bank does not send you a 1099-INT form if you earn less than $10 in interest, but you are still required to report the income on your tax return if you file one. Keep track of your interest earnings throughout the year so you can report the correct amount.