What is the difference between a high-interest savings account and a regular savings account?
The main difference between a standard savings account and a HISA is the interest rate. As suggested by their name, HISAs pay a slightly higher rate than standard savings accounts, allowing savings to slowly grow. They may, however, be subject to withdrawal or transfer limits, transaction fees or minimum balance requirements. A standard savings account is a good place to keep surplus cash that you don’t need for everyday transactions. A HISA, on the other hand, is a better choice for holding savings that are geared toward a particular goal, such as paying for home renovations or university tuition.
How to choose a high-interest savings account
Most financial institutions in Canada offer a HISA, and you will want to consider which is the best fit for your needs. First and foremost, you should consider the interest rate. Conventional wisdom states that you want to look for a rate of interest that outpaces the rate of inflation or you will wind up with less buying power than you started with. In recent years the rate of inflation has been about 2%. During recessions, however, we can expect both interest rates and inflation to decrease.
You also want to carefully look at the terms and conditions of a high-interest savings account. Some may require you to keep a minimum balance, charge fees on transactions, limit withdrawals, or enforce lock-in periods.
Look to take advantage of cash signing bonuses or higher promotional rates, but also keep in mind that the long-term interest rate is more important than a short-term introductory rate.
Different types of savings accounts
A standard HISA is a very safe and secure way to squirrel away some money and earn a small amount of interest in the meantime. For medium or long-term savings, Canadians should consider holding their HISA in one of two types of registered plans that will help mitigate the amount of tax you will owe on your interest earnings.
Tax-Free Savings Account (TFSA)
Tax-Free Savings Accounts (TFSAs) allow you to invest up to $6,000 per year and not pay any taxes on the earnings. You are free to withdraw the money, tax-free, at any time. The savings plans available within a TSFA may have somewhat lower interest rates than some other HISAs, but could be a better choice after considering the tax savings.
Registered Retirement Savings Plan (RRSP)
Registered Retirement Savings Plans (RRSPs) are a tax-deferred retirement savings plan that allows Canadians to defer paying taxes on their income until after retirement.
Canadians can defer paying taxes on up to $27,230 this year and instead hold that money in a savings account (or other types of investments, including stocks, bonds and ETFs) within an RRSP where earnings will accrue tax-free as well. When you withdraw the money to use for living expenses in retirement, it’s typically taxed at a lower rate, assuming your income in retirement is lower than when you made the original contribution.