Can you lose money in a high yield savings account?

High-yield savings accounts have significantly higher interest rates than traditional savings accounts, which currently pay just 0.05% annual percentage yield (APY). High-yield savings accounts pay an average of about 1% APY or about 25 times the national average. High-yield savings accounts are like standard savings accounts but pay a higher APY.

With compounding interest, you earn money on the principal balance and on the interest you’ve already earned over a specific time — usually monthly or quarterly. Over time, your money can really add up, even when interest rates are at their lowest. Even with interest rates at all-time lows, high-yield savings accounts still offer a safe place to stash away your hard-earned money. Again, make sure you use a tool like Credible to weigh your options.

However, high-yield savings accounts carry some potential risks, too. Here's what you need to know.

Can you lose money using a high-yield savings account?

A high-yield savings account is a good option for short-term savings, like adding to an emergency fund, saving for a vacation, or paying for a wedding. But you can also lose money. How?

1. Taxes
2. Inflation

Here's what you need to know.

1. Taxes

Although you don’t pay tax on your initial deposit, any accrued interest is taxed as ordinary income. If you earn more than $10 from an interest-bearing account in one year, you are required to report it on your tax return. But you are not taxed on any deposits you make to your account, only on the interest earned. So, for every dollar you earn in interest, Uncle Sam takes a percentage. In most cases, the tax rate is the same as the rest of your income.

2. Inflation

Inflation also plays a part in how much you can lose on your high-yield savings account.

Let’s say your high-yield savings account pays 2% interest on your $10,000 deposit. After one year, you will have $10,200 in your account if left untouched.

If the inflation rate is 3%, you would need to earn $300 in interest for your money to have the same buying power. As a rule, any time your high-yield savings account doesn’t grow at the same rate as inflation, you lose money.

HERE'S HOW MUCH A HIGH-YIELD SAVINGS ACCOUNT PAYS

What are the other risks?

A high-yield savings account is an excellent place to stash your cash. But they don’t come without a few risks.

1. Interest rates are variable: This means interest rates can fluctuate at any time. So the rate that is advertised when you open your high-yield savings account may not be the rate you get six months later.
2. You're on the hook to pay tax on the interest you earn: This can reduce your tax refund (if you have one coming).
3. You may have to file an amended tax return: If you don’t pay taxes on your earned interest, you may have to file an amended return to the IRS and possibly pay a penalty.
4. You have a limited number of transactions per month: High-yield savings accounts only allow you to make six transactions per month, or you risk fees, and your account may be closed.

HOW ARE HIGH-YIELD SAVINGS ACCOUNT DIFFERENT FROM TRADITIONAL?

How else can I grow my money?

High-yield savings accounts offer higher APYs than traditional savings accounts. But there are other ways to grow your money, each with advantages and drawbacks, such as:

1. Money Market Deposit Accounts
2. CDs

Here's what you need to know about each of these financing options.

1. Money Market Deposit Accounts

Money market accounts offer competitive interest rates, but only if you maintain a comparatively high minimum balance. They are FDIC insured and come with a debit card and check-writing privileges. But you are limited to six transactions per month, and you may pay money maintenance fees.

2. CDs

Certificates of Deposit (CDs) offer higher APYs than most high-yield savings accounts. Unlike high-yield savings accounts where rates are variable, rates on CDs are fixed at the time of deposit. Accounts are FDIC-insured, but you can’t access your money for a predetermined term, or you may pay an early withdrawal penalty.

SHOULD I PUT MONEY IN A HIGH-YIELD SAVINGS ACCOUNT OVER A CD OR MONEY MARKET?

Final thoughts

High-yield savings accounts offer higher APYs than traditional savings accounts and some money market accounts. They come with a few risks, but overall high-interest savings accounts are a good option to save your money.

Looking for more ways to save? Find out how to lower your interest rate and reduce your monthly payments by refinancing your student loans or refinancing your mortgage.

OPEN A HIGH-YIELD SAVINGS ACCOUNT TO EARN MORE INTEREST ON YOUR MONEY