Types of Financial Institutions and Accounts
One of the keys to building a strong financial foundation is ensuring you are using the correct financial accounts for your various needs, wants and goals. Financial institutions are the organizations that house financial accounts, on top of providing a variety of services to its members. First, we will explore financial institutions, including banks, credit unions, and brokerage firms.
- Banks: Banks are for-profit financial institutions that offer a variety of services, such as checking accounts, savings accounts, brokerage accounts, and general financial planning assistance. Depending on if a bank is nationally or regionally focused, they can also have an extensive ATM network, up to date technology and apps, and many convenience features, like remote check deposits. Banks are owned by shareholders, who are not required to hold accounts with the banks they invest in. Finally, banks are insured by the Federal Deposit Insurance Company (FDIC), which ensures $250,000 per depositor, per bank, per account type. This means that if the bank were to fail, you would receive all of your money back up to the $250,000 limit. This makes using banks safer than keeping your money at home. If your home is robbed, or damaged in some way, you risk losing all of your physical money. If the same happens to a bank, you can rest assured that the money you keep with them is safe. Banks may charge monthly maintenance fees, overdraft fees, or a variety of other charges to use their services.
- Credit Unions: Credit unions are financial institutions that are based within local communities. Credit unions tend to have restrictions on who can join, which can be based on occupation, household location, or even the college you go to. Credit unions tend to focus their emphasis on educating and servicing their members through a variety of community outreach programs, like financial literacy workshops. Credit unions are not-for-profit organizations, and are owned and controlled by the individuals who hold accounts with them. Although credit unions tend to haver fewer branches and ATMs than banks, and can lag behind technology updates, they are known for their superior customer service and community focus. In addition, many credit unions offer better terms on financial accounts, such as lower interest rates on loans or lower deposit minimums on financial accounts. Credit unions are insured by the National Credit Union Administration (NCUA), which like the FDIC, insures financial accounts for $250,000 per depositor, per credit union, per account type.
- Brokerage Firms: Brokerage firms are financial institutions that act as middle men between investors and the investment products they want to trade. Brokerage firms, much like banks and credit unions, tend to charge fees to those who use their services. Individuals can use such companies to open general investment accounts and retirement accounts. Brokerage firms tend to be insured by the Securities Protection Corporation (SIPC). However, it is important to know the difference between how brokerage firms are insured when compared to other financial institutions. SIPC insurance only covers losses if the brokerage firm itself goes under. Investment losses on accounts are not covered. This is because investments have an inherent risk of loss at all times, which you take on as the investor.
- Financial Technology Companies: These companies, most commonly known as fintech companies, can offer a variety of financial services and pseudo-banking features. The most common examples of fintech companies include CashApp, Venmo, Square, and Klarna. While you can hold money in many of these fintech companies, it should be cautioned against putting too much cash into them. This is because financial technology companies are not required to be insured under the FDIC or NCUA. If such companies fail, consumers can have a difficult or impossible time getting their money back. However, such companies and apps add a level of convenience, especially with virtual wallet and peer-to-peer (P2P) transaction features, that their bank or credit union may not offer.
Within financial institutions, individuals can hold a variety of financial accounts. These include checking, savings, investing, and retirement accounts.
- Checking accounts: A checking account is a type of financial account that you can withdrawal and deposit money into. Checking accounts typically include a debit card, which pulls funds directly from the account. The ability to write checks is another privilege associated with checking accounts. Checking accounts should be used for day-to-day expenses, since they have unlimited withdrawals. Most checking accounts do not accumulate interest, and may come with monthly maintenance fees or account minimums. Over drafting, or taking more money out of an account than you currently have available, can come with stiff penalties. Checking accounts are insured by the FDIC or NCUA, depending on the financial institution you open them through.
- Savings accounts: A savings account is an interest-bearing financial account, meaning that any money you deposit makes interest, typically on a monthly basis. These accounts are best used for emergency funds and short to medium term financial goals. While savings accounts associated with brick and mortar banks tend to have small interest rates (1% or lower), there are others called High Yield Savings Accounts which offer much higher interest rates. This can help you make money on top of your money, which assists in financial goal achievement. Savings accounts do not come with debit cards, and you typically cannot write checks against the balance. In addition, savings accounts have a limited number of free monthly withdrawals. One should be careful to not withdrawal too many times from such accounts, both to preserve your cash and to protect against unnecessary fees. Some savings accounts may have minimum balance or deposit requirements as well. Savings accounts are insured under the FDIC or NCUA.
- Certificates of Deposits: A Certificate of Deposit, more commonly known as a CD, is a savings vehicle where the account holder agrees to hold a specific amount of money in the account for a specific amount of time. In return, the financial institution will pay the account holder regular interest payments on their deposit. These interest rates tend to be higher than normal savings accounts, but lower than you can make through investing. If the account holder pulls their money before the maturity date (ei, the date the CD expires), they may be subject to fees and a forfeiture of their interest. CDs are a great option for individuals who have a stash of money that they do not need to use right now, but want to see grow. CD date ranges are from a few months up to a decade or longer. CDs, like checking and savings accounts, are also insured under the FDIC or NCUA, depending on if you receive them from a credit union or bank account.
- Money Market Accounts: Money market accounts (MMAs) are another type of savings account that offers higher interest payments than traditional savings accounts. MMAs have features of both checking and savings accounts, in that they offer regular interest payments on your balance, while also allowing checks, debit cards, and ATM access. MMAs tend to have higher minimum deposit requirements than traditional savings accounts, and limit the amount of withdrawals you can make monthly. In this way, MMAs are more convenient than CDs, which require you to keep your money in the account for a specific time, but offers higher interest payouts than checking and savings accounts. These accounts may be best suited for short to medium term financial goals. MMAs are also insured under FDIC or NCUA.
- Brokerage Accounts: A brokerage account is a financial account used to buy and sell investments. With a brokerage account, you can trade stocks, bonds, ETFs, mutual funds, and other financial securities. Brokerage accounts come with their own schedules of fees, which can be based on monthly maintenance, trade costs, or withdrawal amounts. Brokerage accounts should not be used as a way to store your day-to-day funds, nor should it be used to keep important money like your emergency fund safe. Instead, brokerage accounts are used to invest in your long-term goals. The amount of return you see on brokerage accounts are solely based on your investments. Unlike in all of the previous financial accounts discussed, you can lose money on investments, and brokerage accounts cannot be insured against such losses. Investments always come with a risk of loss, but also the potential for higher gains than savings accounts. Investing in a brokerage account should be done with caution and plenty of research, and speaking to a licensed financial planner is highly recommended beforehand. Brokerage accounts can be opened at brokerage firms, banks, and credit unions.
- Individual Retirement Accounts: Individual Retirement Accounts (IRAs) are specific investment accounts that are geared towards retirement. You cannot withdrawal funds from IRAs before retirement age without facing penalties and taxes. Retirement age for IRAs is age 59 1/2. There are two main types of IRA accounts: Traditional and Roth.
- Traditional IRAs: In a Traditional IRA, contributions are made with pre-tax dollars. What this means is that the money you deposit into a Traditional IRA can be written off on your taxes for that year, potentially lowering your tax bill. The funds you invest in a Traditional IRA will grow tax-free, and once you reach retirement age, withdrawals will be taxed at your income tax rate. Traditional IRAs are also subject to Required Minimum Distributions (RMDs). What this means is that you are required to begin withdrawing from your Traditional IRA by age 73. If you do not withdraw, then the account will be subject to fees.
- Roth IRAs: In Roth IRAs, contributions are made with post-tax dollars. This means you cannot make a tax deduction on money you put into a Roth IRA. However, the investments in the account grow tax free, and you do not pay taxes on withdrawals when you reach retirement age. Additionally, Roth IRAs do not have RMDs, meaning you do not have to begin withdrawing funds at age 72.
There are a variety of accounts available to students. Seeking financial education, as well as speaking to a qualified financial professional, can help set students on the right path to financial success, and pick the best financial institutions and accounts for them.