A long-term savings account, as the name implies, is one opened to deposit and hold money for a longer period of time. They can be contrasted to checking accounts used to pay monthly bills or regular savings accounts that might earn interest, but maybe not much. A long-term savings plan might be set up for a child’s college education, for large purchases such as a home, or for retirement, for example. In general, they’re used to save up for a goal that is years away.
Different types of savings accounts qualify as long term, and here’s an overview of options, along with information about setting long-term financial goals and more.
Long Term Savings Options
Here are five options, along with some pros and cons of each of them.
High Interest Savings Accounts
This type of savings account can provide some of the flexibility of a standard checking account while offering higher interest rates than the average savings account. It’s generally just as easy to access a high-interest savings account as it is a standard checking account, although there may be limits on the number of withdrawals you can make per month with this type of savings account. They often offer ATM access, sometimes with fee reimbursement, mobile check deposit, and online account management via an app. Financial institutions that offer these accounts include regional banks, local credit unions, and online banks.
To open and maintain this type of account, there are often certain requirements that need to be met. This could include setting up a direct deposit, maintaining a minimum balance, or limiting the number of withdrawals per month. Some high-interest savings accounts also offer tiered interest rates for different balance ranges. For instance, a bank might offer a base tier of .25% on balances up to $25,000, and an upper tier of .40% on balances greater than $25,000.
One item to check for in the fine print: the balance cap on interest earned. If that’s included, this means that there’s a limit to the balance on which interest can be earned. For example, if the interest rate is 3%, but the balance cap is at $2,500, then the interest rate is only earned on money up to the cap. Any amount above the balance cap will not earn a high interest rate.
Recommended: Is a High Interest Savings Account Right for You?
Money Market Accounts
A money market account is similar to a high-interest savings account, but will likely have more requirements for keeping it open. For example, some accounts require initial deposit minimums, and a certain minimum balance may be required to prevent monthly fees from being charged.
With both high-interest savings accounts and money market accounts, funds can typically be deposited and withdrawn fairly easily.
Certificates of Deposit
A certificate of deposit (CD) is a deposit account that typically offers higher interest rates than a regular savings account and pays compounding interest. In other words, interest is paid on the interest.
One challenge with a CD, though, is that the account holder must agree to keep the funds in the account for a predetermined amount of time. So this may not provide the liquidity—the ability to quickly turn the account into cash—that some people want and need. If funds are withdrawn before the maturity date, a penalty is typically assessed.
Interest rates on CDs are typically structured in tiers, based upon how long a person agrees to keep the money in the account. A two-year CD, then, will likely pay a bit more in interest than a one-year CD.
Recommended: What Is a Certificate of Deposit?
Retirement accounts have one thing in common: they are investment vehicles designed to help people save for their post-working years. They typically have tax advantages. Here are three of the types.
1. Traditional Individual Retirement Accounts (IRAs)
The account holder opens this account and makes contributions on their own instead of through an employer. There may be an income tax deduction allowed on contributions made, and the funds are tax-deferred, meaning the contributions aren’t taxed but the withdrawals are. As of 2021, the maximum allowable contribution amount is $6,000 annually or $7,000 if age 50 or older. If funds are withdrawn before the account holder is 59 and a half, there is a 10% penalty levied on the amount withdrawn in addition to the usual tax on the withdrawal. Contributions aren’t tax deductible if the account holder also has a retirement plan through work and has an adjusted gross income (AGI) above a certain dollar amount.
2. Roth IRA
This is also another type of individual retirement account that a person opens and funds without the involvement of an employer, this time using after-tax money to contribute. This means that account holders cannot deduct contributions on their income tax. However, the balance grows tax-free, and when funds are withdrawn during retirement, they are also tax free. Annual contribution caps are the same as a traditional IRA.
To contribute to a Roth, the account holder must be earning an income. Once that person’s AGI reaches a certain level—for the 2021 tax year, this is $198,000—then the ability to continue to contribute will begin to phase out. If the account holder is filing joint federal income taxes, then the amount is $208,000 for the 2021 tax year.
This type of account is typically best for someone who appreciates the ability to withdraw funds in retirement without paying taxes, and a Roth IRA can work especially well for people currently earning a lower income than they expect to earn in the future.
Recommended: What is a Roth IRA and How Do They Work?
3. 401(K) Retirement Account
This is a retirement plan offered by an employer to qualifying employees. Contributions are made with pre-tax money, which means they will reduce the person’s taxable income. The money grows tax-free, with taxes paid when funds are withdrawn in retirement.
For the 2021 tax year, the maximum annual contribution amount is $19,500; an additional catch-up contribution of up to $6,500 can be made by account holders over the age of 50. These contributions are taken from the employee’s paycheck, and some companies provide matching funds up to a certain amount. Sometimes these accounts have fees that must be paid.
Although these are not the only kinds of retirement accounts available, they are among those most commonly used.
So, returning to this post’s original question, do you need a long-term savings account? The specifics depend upon personal financial goals.
Recommended: Back to Basics: What Is a 401k?
Long Term Financial Goals
By setting long term financial goals, people can create a plan for a more comfortable future and make a commitment to stay on track with savings goals. The reality is that 40% of Americans would find an unexpected expense of $400 challenging for them to pay, a figure that shows how many people are currently living month by month, focusing on the immediate expenses.
Creating a long-term financial plan and focusing on that plan can help people reach financial goals. Steps include setting goals with these five components:
These components are included in “A Theory of Goal Setting and Task Performance,” published by Edwin Locke and Gary Latham.
First, be clear about what, specifically, you want to accomplish—and don’t be afraid to dream big. What challenges might you face? Break your goals into smaller parts to simplify the journey. Prioritize them and make a commitment to follow shorter-term goals, one step at a time, which also helps to gain momentum on the longer-term ones. The excitement that may be felt about this process can help to solidify a sense of commitment.
For some people, it can help to partner with another person and share goals, keeping one another accountable. Or perhaps a mentor can be helpful. Other people may find it more effective to reward themselves when certain goals are met. Whichever method is chosen, it typically works best when progress is regularly reviewed and adjusted, as needed.
Emergency Savings Account
Although saving for long-term goals is wise, it can make sense to prioritize creating and funding an emergency savings account if one doesn’t already exist. It’s usually wise to choose an account type that offers liquidity because this is one where you’ll want quick access if an emergency occurs. A typical recommendation is to keep three to six months’ worth of living expenses in this account. That way, if someone in the household loses a job, an emergency home repair seems to come out of nowhere, or medical bills need to be paid, money in these funds can help to keep all on track or at least mitigate the impact of the expenses.
If using separate savings accounts for different financial goals isn’t something you want or need to do, consider using one main account that lets you save for your financial goals, spend money, and earn money, all in one place instead of keeping track of your money in multiple accounts.
SoFi Money® is a cash management account that offers those things, in addition to other benefits including:
• No account fees.
• No fees with in-network ATMs.
• Mobile check deposit.
• A mobile app for ease of accessing and managing your money.
Save for your financial goals with SoFi Money®.
Photo credit: iStock/AndreyPopov
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Update: The deadline for making IRA contributions for tax year 2020 has been extended to May 17, 2021.
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