Chapter 13 METHODS OF SAVING

Learning Objectives  Explore the ways in which savings can earn interest  Examine the different types of bank accounts that can aid in saving  Describe retirement savings options

Objective 1: Explore the ways in which savings can earn interest

Interest and Your Savings  Banks offer safety and security  Deposits up to $250,000 in bank accounts are guaranteed against loss  Banks offer you interest on deposits Things that affect the amount of interest you’ll get paid:  Length of time depositor commits to leaving the money on deposit  Whether the account is covered by FDIC or NCUSIF  Current market rates of interest

More Information Market Rates of Interest  The Federal Reserve System has a significant impact on the market rates of interest  They control the money supply (therefore the price of money or interest rates)and stimulates the economy or slows it down Liquidity  Refers to how quickly you can convert something to cash without significant loss of value  Accounts that offer a high degree of liquidity usually offer the lowest interest rates

Objective 2: Examine the different types of bank accounts that can aid in saving

Types of Bank Accounts Checking and NOW Accounts The most liquid type of bank account = basic checking (instant access to your money with checks, DC, and ATMs) Demand deposit – money put into a checking account that can be withdrawn at any time NOW Accounts offer interest, but it’s typically the lowest interest rate. They offer interest because you HAVE to have a minimum balance. Interest Bearing Savings Savings generally pay higher rate of interest than NOW accounts but not as much as CDs No check writing services available Most use a savings account to save for a specific purpose (emergency fund, holiday gift fund, vacation) Certificates of Deposit (CDs) WHAT IT IS: a contract between an individual and bank that specifies the length of time an individual will leave a certain amount of money deposited in that bank at a specific interest rate CDs have maturity dates (date you can cash it in) Common maturities = 1 mo, 3 mos, 6 mos, 1 yr, 3 yrs, and 5 yrs If you withdrawal money in a CD early, you will pay a penalty

Types of Bank Accounts Money Market Deposit Accounts MMDA combine some of the features of checking accounts and some of the features of savings accounts. Requires you to have a minimum balance, have no maturity date, pay interest, and offer limited check writing privileges Example: $2,500 minimum balance and 5 checks allowed per month Credit Unions Credit unions differ from other depository financial institutions primarily due to their nonprofit status Does not exist to earn money for investors Exists to serve members Annual Percentage Yield (APY) Compound interest: the way that interest added to an account earns interest Compound frequency: tells you how often the bank puts interest you have earned into your account APY is the interest rate that takes the compounding frequency into account It tells you what your account will really earn on an annual basis once compounding is taken into consideration

Objective 3: Describe retirement savings options

Individual Retirement Accounts - IRAs  WHAT IT IS: A type of savings account created by the government to encourage people to save for retirement  To ensure you use it for retirement, you can’t withdraw from your IRA until you’re 59½  If you withdraw from an IRA before 59½, you will pay a penalty equal to 10% of the withdrawal  Traditional IRAs = tax deductible  When a contribution to an account is tax deductible, the depositor does not pay federal income tax on the amount deposited in the account

IRAs continued  Traditional IRAs are also tax deferred  Tax deferred = the accounts earnings are not taxed until they are withdrawn after retirement  Roth IRAs – contributions are not tax deductible, but the earnings from an account are never taxed, even after withdrawal  Self-employed people may be eligible for a Simplified Employee Pension IRA (SER-IRA)  Functions like traditional IRAs, but have their own contribution limits

Employer-Sponsored Retirement Plans Employer- Sponsored Plan Set up by employer Employer makes contributions to plan on your behalf Used to attract high quality employees They come in two main forms: Defined-benefit Defined-contribution Defined-Benefit Plan Guarantees you a specific amount of income when you retire Based on numbers of years worked and average salary AKA pension plans Defined- Contributions Plan Employer contributes to the employee’s retirement account but does not guarantee a specific retirement benefit Examples = 401(k) and 403(b) – allow employees to make contributions into their own accounts which may feature a range of investment options They’re both named after sections in the IRS code

Annuities  WHAT IT IS: a type of financial product that guarantees annual payments to the owner for a fixed period of time or for a person’s lifetime  Require a minimum investment, typically at least $5,000 – grows tax free and won’t be taxed until disbursed to retiree  Come in 2 forms: fixed and variable  With fixed annuity, the return is a guaranteed amount; with variable annuity, the return depends on the performance of the investment.  *Most annuities have very high fees associated with their initial sale