How opening a high-yield savings account can help you prepare for big financial surprises in 2021
Written by
Writer, Fox Money
Rebecca Lake is a Certified Educator in Personal Finance and has spent more than 10 years of experience covering student loans, credit, and investing. Her byline has been featured at Forbes Advisor, LendEDU, The Balance, and SoFi.
Updated October 16, 2024, 2:45 AM EDT
If the coronavirus pandemic has caused you to rethink the way you spend and save money, you're not alone. According to a McKinsey report published in December 2020, 40% of Americans say the pandemic has caused them to be more mindful about spending.
The financial impacts of COVID-19 have put a fresh spotlight on the need for emergency savings. A Marketplace-Edison Research Poll from May 2020 revealed that almost 60% of Americans would have a hard time footing the bill for a $1,000 emergency expense.
If you have room in your budget to save, a high-yield savings account can offer a convenient place to keep your money. Here are some of the benefits of choosing online high-yield savings accounts:
- Earn higher interest rates than a traditional savings account
- Avoid a monthly service fee or minimum balance requirements
- FDIC protection keeps your savings safe
A high-yield savings account can come in handy for covering a number of expenses, both anticipated and unexpected. Here are three financial surprises that a high-yield savings account could help you prepare for in 2021.
WHY IT'S A GOOD IDEA TO PUT SOME MONEY IN A HIGH-YIELD SAVINGS ACCOUNT
1. Unemployment income taxes
If you're one of the millions of Americans who received unemployment benefit assistance in 2020, you may be in for a surprise tax bill. That's because unemployment benefits are considered to be taxable income in most states.
When you file for unemployment, you have the option to withhold taxes on your benefits. But if you didn't choose to do that, you may have to settle up with the IRS when you file your return. Whether taxes on unemployment income result in owing the government or getting a smaller refund can depend on your overall personal finance picture, including tax credits or deductions you may be eligible for.
If you end up with a tax bill, you could tap into your high-yield savings account to pay it. That may be preferable to using a credit card to pay, which involves paying a processing fee, or taking out a personal loan.
4 REASONS TO OPEN A HIGH-YIELD SAVINGS ACCOUNT RIGHT NOW
2. Taxes on retirement account withdrawals
An Individual Retirement or 401(k) can be crucial to your long-term financial plan for retirement. And in an emergency situation, it may be a source of ready cash.
To help ease financial pressure associated with COVID-19, the federal CARES Act established some temporary rules for retirement account withdrawals. Those rules allow for withdrawals of up to $100,000 from qualified retirement accounts penalty-free.
That's the good news if you need emergency money. The bad news is that, while you won't pay the early withdrawal penalty, you'll have to pay income tax on the money you take out. You'll be able to spread those payments out over three years, but a high-yield savings account could help cover any surprise taxes owed for this year's filing.
WHEN SHOULD YOU USE A HIGH-YIELD SAVINGS ACCOUNT? 5 SCENARIOS
3. W-4 changes
The coronavirus pandemic prompted more companies to encourage remote work but there may be a price to pay if you worked from home for part of the year. Depending on your state's tax laws, you may have been required to update your W-4 form to reflect your new work location.
Failing to do so could result in not having the right amount of taxes withheld from your paychecks. The W-4 form itself is also different this year, as the IRS introduced a new, simpler version.
If you didn't update your the form in 2020 to reflect remote work or to account for the new form, it's possible you could owe taxes in April. That's another scenario where a high-yield savings account could come in handy.
HOW TO CHOOSE A HIGH-YIELD SAVINGS ACCOUNT
Compare high-yield savings accounts online
Opening a high-yield savings account is relatively easy to do. The most important step is finding the right bank.
First, consider whether it makes more sense to open an online savings account or a high-yield account at a brick-and-mortar bank. If you're leaning toward an online bank, consider how easily you could access your savings if you need to tap into it for an unexpected expense.