High-yield savings: what makes the interest rate so high?

The “high yield” comes from two places: the general level of short-term interest rates, which the Federal Reserve steers, and how badly a particular bank wants your deposit. Banks that pay far above average are usually online banks with no branch network to pay for, which need new deposits to fund their lending and win them on rate. Large branch banks sit on huge deposit bases from customers who rarely move their money, so they can pay very little. Your money is equally insured at either, up to the federal limits; what you give up for the higher rate is branch service and some speed in moving money, and the rate itself can drop at any time.

The Fed sets the floor

The Federal Open Market Committee sets a target range for the federal funds rate, the rate banks charge one another for overnight loans, at its eight scheduled meetings a year. The Fed also pays banks interest on the reserves they keep at the Fed. That second rate matters for savers: a bank can earn it with no risk at all, so it is a rough measure of what one more dollar of your deposit is worth to the bank. When the Fed raises its rates, deposits become more valuable and competition for them heats up; when it cuts, savings rates follow down. This is the effective federal funds rate, the average rate banks actually pay each other overnight, not the Fed’s target range:

How closely a savings account tracks that number varies widely. Accounts at banks that compete for deposits tend to move within weeks of a Fed decision, in both directions. Standard accounts at the largest banks barely move at all.

Why some banks pay so much more than others

Three things explain most of the gap. The first is cost: a bank without branches has no rent, tellers or local staff to cover, so it can hand more of what it earns on your deposit back to you. The second is need. A bank growing its loan book has to raise deposits from people who do not already bank there, and a high rate is the cheapest way to get them; a giant bank already has a vast base of checking and savings customers who stay out of habit. The third is marketing. Some top rates are promotional, last a few months, or apply only to part of a balance, and they exist to bring in customers who will stay after the rate drops.

This is also why the averages you see quoted look so low. The FDIC publishes a national average savings rate every month, but it weights each institution by its share of U.S. deposits, so the figure mostly reflects what the biggest banks pay, not what the best accounts offer.

What the difference is worth in dollars

An account’s APY already includes compounding, so on a balance you leave untouched for a year it tells you the dollar result directly. Say your bank pays 0.01% a year and an online bank pays 4%:

• $1,000 earns 10 cents at the first bank and $40 at the second.
• $10,000 earns $1 against $400.
• $20,000 earns $2 against $800.

Interest is taxed as ordinary income in the year it is credited, whether or not you withdraw it. In the 22% federal bracket, the $400 becomes $312 after federal tax, before any state tax.

That gives a practical threshold. Below about $1,000, the difference is small enough that convenience can reasonably win. Above a few thousand dollars, especially money you rarely touch such as an emergency fund, a low-rate account is costing you hundreds of dollars a year for nothing.

Is the money safe at an online bank?

Yes, if it is actually a bank. Deposits at an FDIC-insured bank are insured up to $250,000 per depositor, per bank, per ownership category, the same at an online-only bank as at the biggest bank in the country, and credit union deposits get the same protection from the NCUA. The FDIC’s deposit insurance pages link to its tool for confirming a bank’s status. The case that needs care is an app or fintech company that is not a bank and holds your money at a partner bank: there, insurance applies only under specific conditions and only if the bank fails. Our guide to FDIC insurance limits explains both.

What to check before you open one

1. Whether the APY is promotional. Find out how long it lasts, what it falls to, and whether it applies to your whole balance or only part of it.
2. Minimums and fees. Some accounts pay the advertised APY only above a minimum balance or charge a monthly fee below one. Regulation DD requires the bank to disclose both before you open the account.
3. Transfer speed. Standard ACH transfers to and from your checking account at another bank take one to three business days. Ask about daily transfer limits and whether faster options exist.
4. Withdrawal limits. The Federal Reserve removed the federal six-per-month limit on savings withdrawals in April 2020, but a bank can still set its own limit or fee for excess withdrawals.
5. The rate’s track record. Look up how the bank’s APY moved after recent Fed decisions. A bank that cut quickly and raised slowly is likely to do it again.
6. Who holds the deposit. Confirm the bank’s legal name on the FDIC’s list, or the partner bank’s name if you are opening through an app.

When it is the wrong tool

A high-yield savings account is built for holding cash, not moving it. Many do not come with a debit card or checks, so it cannot replace checking for bills. It is not an investment account either: over decades, cash in savings has grown far more slowly than diversified stock investments, which in exchange carry the risk of loss.

And it is not always the best place for cash you will not touch for a fixed period. If you know you will need a sum on a specific date, a certificate of deposit or a Treasury bill locks in a rate that a variable account cannot promise; our comparison of CDs and savings accounts works through when the lock is worth the penalty for breaking it.