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Understanding How to Calculate Interest on Savings Accounts

David Rodeck • June 3, 2024

A woman sitting at her desk to determine her interest savings using a calculator.

Imagine tucking $100 away in a drawer. Now imagine returning to that same drawer a year later and discovering it had turned into $105 without any effort on your part. That’s the magic of earning interest on a savings account! With a savings account, your money can grow while you go about your daily life.

Understanding how to calculate interest on savings accounts can help you to make better financial decisions and plan for the future.

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Learn to calculate interest in your savings account

Essentially, interest is what the bank pays you for allowing them to use your money. It’s similar to how you’d have to pay them to borrow money through a loan.

Let’s break interest down with a simple calculation. The easiest interest rate formula is:

Interest = Principal × Rate × Time

  • Principal is the starting amount in your savings account.
  • Rate is the bank’s interest rate, expressed as a percentage.
  • Time is the length of time you keep money in the account.

With this formula, you can figure out how much money you could earn by keeping your money in a savings account.

Interest rate formula

If you have $1,000 in a savings account with an annual interest rate of 5% (or 0.05 as a decimal), and you leave it untouched for one year, the calculation would be:

Interest = $1,000 × 0.05 × 1 = $50

This means that after one year, you’d earn $50 in interest, bringing your total balance to $1,050. The more you have in your account, the more you earn. Building wealth gets easier as you grow your savings.

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Understanding simple and compound interest

Interest on savings can be calculated in two main ways: simple and compound. Simple interest is a straightforward annual interest rate formula calculated only on the principal amount, year after year.¹

Going back to the previous example, if you have $1,000 in your account earning 5% simple interest, you would earn $50 year after year. You don’t make interest off your interest earnings.

Most bank accounts are more generous and use compound interest rates. Compound interest is calculated on the principal plus any previously earned interest. In other words, the bank pays interest not only on what you deposited but also on your earnings throughout the year.²

While that might seem like a small change, it can greatly affect how quickly your money grows. For example, imagine you earn 5% a year with compounding once a year. Here’s how your money grows over three years.

  • Year 1 = $1,000 x 5% = $50 of interest = $1,050 total balance
  • Year 2 = $1,050 x 5% = $52.50 of interest = $1,102.50 total balance
  • Year 3 = $1,102.50 x 5% = $55.13 of interest = $1,157.63 total balance.

In contrast, using simple interest, you would earn only $150 over the same period: $50 per year over three years. Compound interest gives you an additional $7.63.

Savings account compounding

A savings account could compound annually, monthly, and even daily. The more often an account compounds, the faster your money grows. You get paid interest on your interest more frequently.²

If you want to calculate interest on savings accounts with compounding, here is the compound interest formula:

Compound Interest= P * (1 + r/n)nt – P

P = Principal

r = Interest rate

n = Number of times interest is applied in a year

t = Time

This calculation can get tricky to do on your own, especially if you use monthly or daily compounding. You can use a free online calculator to speed up how to calculate monthly interest on a savings account.

Reasons to calculate interest earned

You don’t need to do any math to collect your interest. Your bank will handle the calculation and deposit the earnings into your account. Still, understanding how to calculate interest on savings accounts can help with your financial planning in a few ways:

  • Budgeting: You can budget for future goals by planning your interest earnings. You can see exactly how much your money will grow over time. That way, you know when you’ll hit your savings goal for that upcoming vacation, a new car, or a home down payment.
  • Taxes: You owe income taxes on your interest earnings every year. If you don’t know what to expect, that bill could be an unpleasant surprise come tax season. By tracking your interest earnings, you can figure out how much to set aside for the IRS based on your tax bracket.³
  • Saving more: Saving is a habit. Seeing how much your money will earn over time can inspire you to put even more aside by increasing your savings.

Tips for increasing your savings

Boosting your savings can be simpler than you think. Here are some strategic ways to maximize your savings growth:

  • Put money into high-interest savings accounts: Different bank accounts pay different interest rates. You’ll earn more in a savings account than in a checking account. Keep only the money you need for day-to-day spending in checking. Put the rest in a high-interest savings account for growth.
  • Select your financial institution carefully: Not all savings accounts are created equal. Look for one that offers a high-interest rate and low fees. Online options and fintech companies may pay higher rates. They don’t need to pay for physical branches, leaving more money for interest.
  • Take advantage of rising interest rates: Savings account interest rates depend on inflation and market rates set by the Federal Reserve. When rates rise, you have a chance to earn even more money. Check that your current bank increases its saving account interest rates to keep up with new market conditions. If not, it could be time to switch.
  • Regularly deposit funds: Consistent deposits help you take advantage of compounding interest by building your savings faster. You can schedule automatic deposits to go into your savings account right after payday. That way, you won’t be tempted to spend the money first.
  • Work on your budget: Make a list of your monthly expenses. Search for opportunities to save money, like eating more at home instead of at restaurants, canceling unused subscriptions, and finding discounts on frequent purchases like groceries. Every dollar you save in your budget is a chance to earn more interest.

Putting your savings to work

You work hard to earn your money, so make sure it’s working just as hard for you. You can earn more on your savings by understanding how to calculate interest rates and finding the right accounts.

It’s an important step towards reaching financial security and your long-term goals. For more money tips, find out how to build a financial plan based on your new savings.

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¹ Information from the Corporate Finance Institute's "Simple Interest," as of May 10, 2024: https://corporatefinanceinstitute.com/resources/commercial-lending/simple-interest-definition/

² Information from the Corporate Finance Institute's "Compound Interest Formula," as of May 10, 2024: https://corporatefinanceinstitute.com/resources/wealth-management/compound-interest-formula/

³ Information from the IRS' "Topic no. 403, Interest received," as of May 10, 2024: https://www.irs.gov/taxtopics/tc403

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