Why a Long-Term Savings Account is Important and How to Choose One

You probably have financial goals: Some of them may be short-term, while others may have a timeline stretching further into the future. If your goal is five years or more away, such as saving for your child’s college education or getting ready for retirement, opening a long-term savings account can help you work toward it.

Long-term savings accounts, which can include options ranging from money market accounts to IRAs, allow you to build savings over an extended period of time through regular contributions and earned interest. We’ll walk you through how to choose the right long-term savings account for you.

How to pick the right account for your long-term savings goals

1. Identify your savings goal and time horizon

The type of long-term savings account you choose will depend on your needs and investment time horizon. It’s important to match the type of account you use with your goals in order to select the best long-term saving plan for you.

For example, your long-term goal may be to save for college for your child. If your child is a newborn, your timeline is much different than if they were entering high school. In one case, your money has well over a decade to grow; in the other, you will need to start withdrawing funds within a few years. By establishing a timeline, you can choose the correct savings product based on the number of years you have left to save.

Your timeline can also indicate your risk level. If your child is a toddler, you may be more comfortable putting your college savings account in funds that can be more volatile, such as stocks or mutual funds, as you’ll have more time to recover from any losses. But if you need the money soon, you might gain peace of mind by putting it into a fund with less risk, such as a certificate of deposit (CD) or money market account.

2. Consider how much liquidity you may need

Another concern to weigh is liquidity: Consider how much access you may need to your funds, and compare that to the type of access an account offers. In general, if you need more liquidity, you may have to accept a lower interest rate, such as those offered with a savings account at a bank or credit union. While you are limited to six “convenient” transactions a month, per Federal Regulation D, you can withdraw funds whenever you wish without paying a penalty for high liquidity (see note).

Another option that offers a high level of liquidity is a money market account. It’s similar to a deposit account, although it usually requires a larger initial deposit as well as a higher minimum balance. Because of these requirements, money market accounts typically pay higher interest rates. This makes a money market account a good choice for an emergency fund, since it is accessible but also earns more interest. However, it’s important to note that money market accounts are also subject to Regulation D, and you’ll be limited to six convenient transactions each month (see note).

If you don’t need funds that are as liquid, you can look into a long-term CD, which can range from a few months to as many as 10 years, but charges an early withdrawal penalty if you need to take your money out sooner than that. If you’re comfortable keeping your funds tied up, though, you can enjoy a higher interest rate compared to some other deposit products.

3. Compare interest rates and note fees

Once you understand your timeline and liquidity needs, compare savings account offers to look for the best interest rates. Maximizing your earnings will help you achieve your investment goals faster.

For example, if you put $10,000 in a traditional savings account at a bank that pays an APY of 0.01%, with interest compounding monthly, in five years you would have $10,005 with no further contributions. If you put that same amount in a high-yield savings account that offers a 1.50% APY, your balance in five years would be $10,778.34. Or, you could put your money into a five-year CD that pays 2% APY and have $11,050.79 at the end of the term.

You should also look into any account fees. For example, a money market account may charge you a fee if your balance dips below a certain level. If you choose to invest in a CD and need to access your money, you can also incur hefty early withdrawal penalties. These costs can cut into your total savings.

Long-term savings options to consider

High-yield savings account

• Most important consideration: Safety, liquidity
• Estimated time horizon: Short-term

While many brick-and-mortar banks pay interest rates on savings accounts that can be considered negligible, online financial institutions can offer high yield-savings accounts with APYs above 1%. These accounts can be your best place to save money for an emergency fund or a short-term goal, as they offer high liquidity and are insured for up to $250,000 per depositor, in each ownership category, at any one insured institution. Accounts at banks are insured by the Federal Deposit Insurance Corporation (FDIC), and accounts at credit unions are insured by the National Credit Union Administration (NCUA).

You may give up convenience of local branches or the ability to make ATM withdrawals by working with an online-only institution, but higher earnings can offset those drawbacks.

Certificate of deposit (CD)

• Most important consideration: Safety, yield
• Estimated time horizon: Short-term and long-term

CDs can serve as a low-risk investment savings account for both short-term and long-term goals. Financial institutions offer terms that range from three months to six years or more. CDs are insured by the FDIC and NCUA for up to $250,000 per depositor, in each ownership category, at any one insured institution.

CDs usually pay higher interest rates than high-yield savings or money market accounts. However, with that rate you sacrifice liquidity, since your money is tied up for the term of the CD. If you need to access the funds, such as in the case of an emergency, you could be subject to early withdrawal penalties. In addition, you generally can’t add more money to your CD once it’s set up. If you want to make an additional investment, you’ll need to open another CD account.

One way to increase liquidity with CDs is to create a CD ladder, with accounts that have varying maturity dates. This can help provide ongoing access to your investment once you get past the first CD’s term.

Money market account

• Most important consideration: Safety, liquidity
• Estimated time horizon: Short-term

Money market accounts offer higher interest rates than traditional savings accounts, and some have APYs similar to those of high-yield savings accounts. This type of investment combines features of both checking and savings accounts, providing limited check-writing abilities. Accounts are insured by the FDIC and NCUA for up to $250,000 per depositor, in each ownership category, at any one insured institution. Due to its liquidity and safety, a money market account can be a good place to keep an emergency fund.

In exchange for the higher interest rate, though, money market accounts often require a higher minimum opening deposit or minimum monthly balance. Also, remember that like a savings account, money market account owners are limited to six withdrawals per month (see note).

Retirement accounts

• Most important consideration: Yield, taxes
• Estimated time horizon: Long-term

Individual retirement accounts (IRAs) and employer-sponsored retirement plans, such as 401(k) plans, can help you reach your goal of retirement. These accounts can supplement government Social Security benefits to provide a greater sense of financial well-being.

IRAs and employer-sponsored retirement plans also offer tax advantages. For example, contributions to a traditional IRA or 401(k) are made through pre-tax deferrals. Roth IRA contributions are made with after-tax dollars, but qualified distributions are tax-free in retirement.

Retirement savings can be invested in stocks or mutual funds, offering the potential for greater gains than other savings products for long-term investment strategies. However, they also have higher risk if the funds decrease in value. Also, stocks and mutual funds are not protected by the FDIC, since they are considered an investment product.

Retirement savings can also be invested in CDs and savings accounts, which may be insured by the FDIC or NCUA.

Additionally, retirement accounts are long-term savings accounts with limited liquidity. If you need to withdraw money from a traditional or Roth IRA before you reach age 59 ½, you can be charged a 10% early withdrawal tax unless the money is being used for certain expenses, such as qualified education expenses or a first-time home purchase.

College savings plans

• Most important consideration: Yield, safety, liquidity
• Estimated time horizon: Short- and long-term

If you’re looking for how to store cash in the long term for your child’s college education, 529 college savings plans and Coverdell Education Savings Accounts (ESAs) are two commonly-used options. Contributions to a 529 college savings account grow tax-deferred, and withdrawals are tax-free as long as they’re used for qualified education expenses. Most 529 plans offer a range of investment options, balancing risk and security based on the number of years until the beneficiary is ready for college.

A Coverdell ESA also grows tax-deferred, and offers tax-free withdrawals for education expenses. However, annual contributions are capped at $2,000, and account holders are not allowed to make additional contributions after the beneficiary's 18th birthday unless he or she is special needs. Another difference is that all of the funds must be withdrawn by the time the beneficiary turns 30 or the account will be subject to a tax penalty.

Short-term vs. long-term savings account: Why you need both

Your financial goals will likely have a variety of timelines, and having a mix of short-term and long-term savings accounts can help you maximize liquidity, security and interest earned.

It helps to understand short-term versus long-term goals. Some short-term financial goals could include saving for a new car, this year’s annual vacation or new furniture. Long-term financial goals may include saving for college, retirement or the purchase of a house.

Of course, where you are in your planning process could change a long-term goal into a short-term one. If you’re nearing retirement age, or if your child is in high school, the timeline for those long-term plans is shortening, and your savings should transition from a long-term savings account to one of the best short-term savings accounts.

It’s also important to balance risk with liquidity for your financial strategy. You don’t want to have your nest egg invested in a high-risk investment, such as individual stocks, if you are retiring in a year or two. On the other hand, lost opportunity can also be considered a risk. If you stash your retirement money in a low-interest savings account when you’re in your 20s or 30s, the interest you receive isn’t likely to keep up with the rate of inflation.

By having a mix of short-term and long-term savings accounts, you can plan for the future — both the immediate and the one on the distant horizon.

Note: On April 24, 2020, the Federal Reserve amended Regulation D to delete the six-per-month limit on convenient transfers from "savings deposits." This change to Regulation D does not require banks and credit unions to eliminate their six-per-month limit, and thus many have chosen to maintain the six-per-month limit.