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Banking

What is a savings account and how does it work?

A savings account is a type of bank account that allows you to deposit money and earn interest from it. A savings account is a great vehicle for saving money towards things that you want to buy all while earning some interest.

How does it work?

A savings account is different from a cheque account because with a savings account you don’t have the option to withdraw your money instantly. Banks loan out the money that you deposit to your savings account. They loan it out at a much higher interest rate, they use the money earned on interest to pay you your interest.

There are a lot of options when it comes to a savings account, here are some of them.

  • Flexible savings account – This savings account allows you to choose the amount of money that you wish to put in your savings account and the term. The interest rate from this account is usually very low, usually around 2% per year. You can usually withdraw your money from this account after a 30 days notice.
  • Fixed-term savings – This savings account allows you to make a fixed deposit for a fixed period of time. This term ranges anywhere from 6 months to 5 years. Interest rates on this option are usually higher at 5% – 8%. Which is actually a lot, it’s hard to find an interest rate of 8% on most investment assets.
  • Tax free savings account – This account allows you to save money and not pay tax on your interest. However, it has its limitations, you can not deposit more than R36 000 in a year and the maximum amount that you can deposit under this option is R500 000. Contributions over these limits are taxed at 40%. Interest rates range anywhere from 2 to 5 percent.

Taxation

All interest that you earn on a savings account is taxable as ordinary income. The interest is treated as income that you would have earned doing your normal day job.

Individual taxpayers enjoy an annual exemption on all South African interest income they earn, set by SARS every year. For both 2018 and 2019, this exemption is R23,800 for individuals under 65 years old and R34,500 for individuals 65 years and older.

Inflation

This is one thing that a lot of South Africans are not paying attention to, it’s very important to factor in inflation when opening a savings account with any bank. The inflation rate is currently hovering around 4 and 5 percent. That is how much value your money loses each year.

Putting your money in a savings account that earns 2% interest while the inflation is 4% is quite futile. The money on your savings account will lose value by 2% in this scenario, always choose an option that offers an interest rate that is higher than the inflation by at least 1%.

Some banks like FNB offer inflation linked savings account, your interest rate is fixed but adjusted for inflation. This is the best option, considering the rate at which inflation is growing in South Africa.

Conclusion

Savings accounts don’t charge a lot of fees like normal cheque accounts. There are other investment vehicles that offer a greater interest than savings account. Do you have any thoughts or questions? Comment below

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