Both savings accounts and Roth IRAs are financial tools that can help you save and grow your money. The primary function of a savings account is as a highly liquid asset that stores cash needed for emergencies or for short-term savings goals. By contrast, a Roth IRA is meant to fulfill the long-term goal of growing your retirement savings through personal contributions and investments.
Whether you’re trying to save cash for a down payment on a house, to make sure you have enough money to retire comfortably, or to cover any other financial need or goal in between, it can be difficult to figure out where you should put your money, as there are multiple options that may best fit your needs.
Roth IRAs and savings accounts are two of those options for depositing your extra cash, but they have different purposes, limitations, and requirements you should be aware of. Keep reading to learn about the similarities, differences, advantages, and disadvantages of these two important financial products.
Roth IRA vs. savings account
Roth IRAs and savings accounts both offer a secure way to save money for short-term goals, such as a vacation, as well as long-term goals, such as retirement planning. That said, there are a few key differences between a savings account and a Roth IRA that are worth knowing before you choose one over the other. James Allen — a CPA, CFP, and CFEI and founder of Billpin.com — explains it best:
“The similarity lies in their purpose — to provide a safe place for your money. However, the differences are stark. A savings account is like a small garden in your backyard: it’s easy to access, and you can add or remove plants (money) anytime, but the growth (interest) is minimal. On the other hand, a Roth IRA is like a vast farm: it’s not as easily accessible, and there are rules about when and how much you can harvest (withdraw), but the potential for growth (returns on investments) is significantly higher.”
How do savings accounts work?
Savings accounts are straightforward financial tools that everyone should have. They are designed to store your cash deposits and provide liquidity, meaning you can access the money quickly and easily. They also come with higher interest rates than checking accounts, so your money will grow faster. Savings accounts are offered by traditional banks and credit unions, as well as by online banks.
Uses for savings accounts
One of the most common uses for a savings account is to hold an emergency fund. Most financial advisors recommend having at least three to six months’ worth of living expenses in your emergency savings — a number that will depend on the size of your household, your income, and your monthly bills.
A savings account is also a great way to save for short-term financial goals. A few examples include setting aside funds for a down payment on a car or a house, tucking away money for your next vacation, or saving up to pay for a wedding. You may also want a safe place to temporarily store your money before putting it toward investments, such as mutual funds. Some people may even benefit from having multiple accounts to keep their savings goals separate.
A savings account is one of the safest places to keep your money, which is particularly comforting during times when the economy is volatile. Your money is never in danger in a savings account because it’s insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) if it’s kept in a bank or the National Credit Union Administration (NCUA) if it’s kept in a credit union.
Drawbacks of savings accounts
It’s important to remember that while your money does earn interest in a savings account, you’re not going to get rich from that interest alone. The national average interest rate on savings accounts is less than 1% — although you can find much better rates on high-yield savings accounts, which can go as high as 5%. Keep in mind, however, that these accounts may have minimum deposit and balance requirements, and the funds may not be as readily accessible.
Pros and cons of savings accounts
Here is a list of the benefits and the drawbacks to consider.
- Highly liquid/easy access to funds
- Unlimited deposits
- Earns interest
- Deposits don’t decrease in value
- Lower interest rates
- No investment component
- May come with minimum balance requirements
How do Roth IRAs work?
A Roth IRA is a specific type of individual retirement account (IRA). Unlike traditional IRAs or 401(k)s, Roth IRAs are funded with after-tax dollars. This means that even though you don’t get the upfront tax advantages that you would with other retirement accounts, you won’t have to pay tax on your withdrawals.
In addition, because you contribute after-tax dollars to a Roth IRA, you are allowed to withdraw your Roth IRA contributions at any time, tax-free and without penalty. However, you will be taxed on any earnings you make if the IRA isn’t at least five years old and you’re not 59 1/2 or older, with a few exceptions.
One of the best features of Roth IRAs is that you have a variety of investment options to choose from to grow your nest egg. Most financial institutions limit your investment to specific choices of products and securities, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), and CDs. This should be fine for most people, but if you’re interested in alternative investments, such as cryptocurrencies or real estate, self-directed retirement accounts offer these options as well.
Limitations of Roth IRA accounts
On the downside, a Roth individual retirement account has annual contribution limits, so you can’t simply deposit as much money in your account as you want. As of 2023, the contribution limit for IRAs is $6,500 per year, or $7,500 if you’re 50 or older. By comparison, there is no limit to how much money you can deposit in your savings accounts.
Also be aware that annual contribution limits include all of your IRAs. For example, if you have two retirement accounts — a Roth IRA and a traditional IRA — you can only contribute $6,500 total (or $7,500 if you’re over 50) between both of them. How much you can contribute to your Roth IRA is also subject to income limits.
Pros and cons of Roth IRAs
Here is a list of the benefits and the drawbacks to consider.
- Good vehicle to save for retirement
- Potential for higher returns
- Variety of investment options
- Money can be withdrawn tax-free (as long as you meet certain requirements)
- Potential to lose money
- Not as liquid as savings accounts
- Subject to income limits
- Annual contribution limits
- Potential penalties and/or taxes on some withdrawals
Savings account vs. Roth IRA: Which is the best account?
In truth, neither a savings account nor a Roth IRA can be considered “better” than the other. Despite their similarities, they each have a distinct purpose, which means they both have a place in your financial stability and future. That said, depending on what stage you’re at in your life, one may make more sense than the other.
“When opening a savings account or a Roth IRA, consider your financial goals, time horizon, and risk tolerance,” says Allen. “It’s like deciding between renting a house or buying one. Renting (savings account) is straightforward but offers limited benefits. Buying a house (Roth IRA) requires more commitment and understanding, but the potential benefits are substantial.”
Should you have both a savings account and a Roth IRA?
If you can manage it (and you’re within the income limits of an IRA), it’s a great idea to have both types of accounts. Allen compares this choice to deciding whether to buy a bicycle or a car — it’s actually great to have both.
“It’s like having both a checking and savings account: they serve different purposes but complement each other. A savings account, like a bicycle, is simple, easy to use, and great for short-term needs. It offers liquidity and accessibility. A Roth IRA, like a car, is more complex and requires more understanding, but it’s powerful and essential for long-term journeys like retirement. It offers potential for higher returns and tax-free withdrawals in retirement.”
Not sure which account to open first? While having both accounts is a solid goal, you should definitely start with a savings account to at least build up your emergency fund. This is especially true if you’re younger and don’t have a lot of extra cash to start saving for retirement yet.
Should I use my Roth IRA as a savings account?
While technically you could store your savings in a Roth IRA, financial experts don’t recommend it based on the primary purposes of each financial product. For example, it can take more time to withdraw money from a Roth IRA and transfer it to your checking account in case of an emergency.
“Using a Roth IRA as a savings account is like using a race car for daily commuting. Yes, it’s possible, but it’s not using the tool for its intended purpose. Roth IRAs are designed for long-term growth and retirement savings, not for frequent transactions or short-term savings,” Allen explains.
How many times a month can I take money out of my savings account?
Prior to the start of the pandemic in 2020, the Federal Reserve Board imposed a limit of six withdrawals per statement cycle from savings and money market accounts. As of April 2020, however, those restrictions have been lifted to give people easier access to their much-needed bank account funds. Having said that, some banks still impose withdrawal limits, which could incur a small fee if you surpass them.
- Roth IRAs and savings accounts are both great places to deposit money for future use, but they have different purposes and restrictions.
- Savings accounts are highly liquid assets and are best for short-term goals, but the interest rates on these accounts are relatively low (except for high-yield savings accounts).
- Roth IRAs are designed for retirement savings and come with tax benefits that savings accounts don’t. However, they are not as liquid, and you may need to pay taxes or penalties for early withdrawals on your contribution’s earnings.
- For optimal financial success, strive to have both a savings account and a Roth IRA. If you don’t have the means to open both yet, start with a savings account to build up an emergency fund.
View Article Sources
- Individual Retirement Accounts (IRAs) – Investor.gov
- IRA FAQs – IRS.gov
- About the Federal Deposit Insurance Corporation (FDIC) – Federal Deposit Insurance Corporation (FDIC)
- About NCUA – National Credit Union Administration
- Investor Alert: Self-Directed IRAs and the Risk of Fraud – U.S. Securities and Exchange Commission
- How to Avoid Tax on a Savings Account – SuperMoney
- Should I Open a Savings Account and Why? – SuperMoney
- How Much Cash Should I Have On Hand? – SuperMoney
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- How Much Money Should I Save Before Moving Out? – SuperMoney
- Can you have both a Roth IRA and Traditional IRA? – SuperMoney
- How to Invest in Index Funds – SuperMoney
- 401k Plans: Complete Guide on 401(k) Retirement Plans – SuperMoney
- Roth IRA Contribution Limits for 2023 & How to Get Around The Roth IRA Income Limit – SuperMoney