Apr
17
2023
How Safe Is a Checking Account?

How Safe Is a Checking Account?

By | Budgeting & Goals, Financial Independence, money | Comments Off on How Safe Is a Checking Account?

In light of recent events, some bank customers may wonder how safe a checking account is in terms of stashing their cash.

Banks are far better for protecting your hard-earned cash than you keeping a wad of bills hidden somewhere in your home — mainly because the money you deposit in a bank is insured up to $250,000 or possibly more1.

But there’s more to the story. So read on, and we’ll tell you in detail how banks make sure your money is well defended — and what you can do to help keep those dollars safe.

Is My Money Safer at a Bank?

It’s only natural to wonder where your money is safest, and keeping your cash on deposit at a bank is one of the safest things you can do. For one thing, carrying cash with you — or, worse, hiding it in your house — leaves you vulnerable to theft or loss (or some other unforeseen event).

In addition, banks are highly regulated and, as mentioned, deposits are insured. And as many people now know, the government is fully invested in protecting the cash of its citizens.

Why Your Money Is Safer in the Bank

Here are some of the protections your checking account may have:

•   FDIC insurance

•   NCUA insurance

•   Capital requirements

•   Protection from fires, floods, and thefts

Read on for a brief description of these protections.

FDIC Insurance

The Federal Deposit Insurance Corporation (FDIC) protects people who deposit money into FDIC-insured financial institutions against loss. This kind of insurance is backed by the federal government and depositors are automatically insured, generally up to $250,000 per depositor, per FDIC-insured institution, per ownership category. (Some banks participate in programs that extend the FDIC insurance to cover millions.) If your bank were to go out of business, you’re covered up to the cap.

NCUA Insurance

Maybe you’re the kind of person who prefers to keep your cash at a credit union. Don’t worry; it’s still safe. Congress created the National Credit Union Administration (NCUA) in 1970 to insure deposits of up to $250,000 at federally insured credit unions. The $250,000 is for each member, per insured credit union, per ownership category. Basically, NCUA is an agency that provides coverage for credit union members that’s comparable to what FDIC does for bank customers.

Capital Requirements

Banks and other financial institutions that accept deposits must have enough liquid assets to cover their expenses while still being able to provide cash when depositors request withdrawals. Formulas to calculate capital requirements can be complicated, but know that they are in place and are protecting you.

A financial institution is required to have a risk-to-asset ratio of at least 4% to safeguard people who deposit funds into their institution.

Protections From Fires, Floods, and Thefts

Banks purchase banker blanket bonds, which protect the institution in case of fire, flood, robbery, embezzlement, earthquakes, and other causes of lost funds. As a result, even if the bank loses money, customers won’t lose their funds.

Get up to $300 when you bank with SoFi.

No account or overdraft fees. No minimum balance.

Up to 3.80% APY on savings balances.

Up to 2-day-early paycheck.

Up to $3M of additional
FDIC insurance.


Advantages of Keeping Money in a Checking Account

Now, let’s pull back and take a big-picture look at why a checking account is such a sweet spot for protecting your money. Some of the pluses:

•   Your money is covered from loss when deposited in an FDIC-insured bank or an NCUA-insured credit union.

•   If your funds exceed the amount of these significant coverages ($250,000), then you can simply open accounts at an institution that offers an insurance program with a higher amount. Or you might open additional accounts at other insured banks and be covered through those institutions.

•   Interest-bearing checking accounts (though not all checking accounts do pay interest) allow you to earn money simply by keeping it in the account.

•   You can easily use your deposited funds by writing a check, withdrawing money from the bank or by an ATM, or transferring it.

•   Checking accounts that come with debit cards make it simple to make purchases through a card reader in person or by entering data online. (Note: There are cons of using a debit card online, like less fraud and purchase protection.)

•   Mobile banking makes it easy to conduct financial transactions wherever you go. You may be wondering, Is mobile banking safe? The answer is yes, most of the time, but you do need to take some precautions to avoid potential hacking activity (more on that below).

•   You can have your paycheck automatically/directly deposited into your checking account. This eliminates a paper check that could get lost or stolen; plus, you don’t have to physically deposit it yourself on payday.

•   A checking account can provide a record of what you spent — and when and where — which is helpful with budgeting, at tax time, and more.

•   Some banks allow you to get paid up to two days early — meaning that your direct deposit is available 48 hours before it’s actually deposited.

Your Role in Protecting Your Money in the Bank

You’ve learned about how banks safeguard your deposits…but what about your role in protecting your money? Yes, even when your dinero is locked up tight at a bank, your actions can impact its security. Consider the following points:

•   If you have any reason to believe that fraudulent activity is occurring or has occurred with your checking account, contact your bank immediately as well as local law enforcement.

•   Create a unique password for your checking account; consider storing it in a secure password management system. Then regularly change your password.

•   Regularly check your balance and balance your statements. This way, you can spot suspicious-looking activity early and address any discrepancies. Identity theft is not unusual and a proactive approach is the best way to protect yourself.

•   Be especially careful when using public Wi-Fi at libraries, coffee shops, and the like. While they’re convenient for information gathering, when you’re conducting financial transactions on them, the open connection makes it easier for hackers to do bad things.

•   Keep your own computer up to date, installing appropriate software updates, malware blockers, and so forth.

•   Sign up for fraud alerts with your bank. Receiving real-time transaction info through texts, emails, or mobile apps allows you to quickly respond to any attempts at fraud.

•   Also, don’t share your banking information with anyone by phone or email. For example, if someone claims to be a representative from your financial institute, hang up. Then use the contact information you have for your bank and share what happened.

The Takeaway

So, how safe are checking accounts? At insured institutions, depositors enjoy deep levels of protection. Besides being safe, there are numerous advantages to having a checking account. Definitely a win-win versus hiding your bucks somewhere at home. But depositing your funds is just part of the bargain: Then you have to do your share and keep vigilant and make sure that fraudsters don’t get their fingers on your dough.

If you’re looking for a bank that protects your money with 24/7 account monitoring, apply for an online bank account with SoFi. SoFi recently announced that deposits may be insured up to $2 million through participation in the SoFi Insured Deposit Program. But here’s what else: If you sign up for direct deposit with us, you’ll earn a competitive APY. Plus, you’ll pay no account fees, and you’ll be able to access your paycheck up to two days early.

Better banking is here with  up to 3.80% APY on SoFi Checking and Savings.

FAQ

Is your money safe in a checking account?

Yes, your money is safe in a checking account. Federally insured banks and credit unions automatically protect depositors like you for up to $250,000 per person, per insured institution, per ownership category (or possibly more). These financial institutions are even covered in case of fire, flood, and earthquakes, as well as when crimes, such as robbery and embezzlement, occur.

What are the risks of a checking account?

Checking accounts come with plenty of benefits and, at federally insured financial institutions, with solid protection against risk. That said, there are a couple of potential disadvantages to checking accounts. For example, not all of them pay interest (although some do). Some come with monthly fees (which can get pricey). And some financial institutions will require a minimum balance in your account.

There’s also some risk of criminal activity: If you ever suspect that someone has hacked into or otherwise fraudulently used your checking account, contact your bank and local law enforcement.

Can someone steal your checking account?

Physical checks and debit cards can be stolen, and your account could be hacked. So keep all personal data in a secure place and, if any items are lost, contact your financial institution immediately. If you believe your checks or debit card to be stolen, also inform your local law enforcement.

Photo credit: iStock/akinbostanci

1SoFi Bank is a member FDIC and does not provide more than $250,000 of FDIC insurance per depositor per legal category of account ownership, as described in the FDIC’s regulations. Any additional FDIC insurance is provided by banks in the SoFi Insured Deposit Program. Deposits may be insured up to $3M through participation in the program. See full terms at SoFi.com/banking/fdic/terms. See list of participating banks at SoFi.com/banking/fdic/receivingbanks.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2025 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Mar
15
2023

FDIC Insurance: What It Is And How It Works

By | Budgeting & Goals, money, Terminology | Comments Off on FDIC Insurance: What It Is And How It Works

With the Federal Deposit Insurance Corporation (FDIC) recently in the news, many people are wondering what the FDIC is, exactly, and what it does.

The Federal Deposit Insurance Corporation, or FDIC, is an independent agency of the U.S. government. In the unlikely event of a bank failure, it protects you and reimburses your deposits, typically up to $250,000 per depositor, per insured bank, per account ownership category.

People often take the FDIC guarantee for granted now, but it was created from a very real need and has kept many people and their money safe.

Here, you’ll learn more about this important aspect of banking, including:

•   What the FDIC is

•   What the FDIC does

•   How does the FDIC work

•   Which accounts are and are not eligible for FDIC protection

What Is the FDIC?

The FDIC is the shorthand way of referring to the Federal Deposit Insurance Corporation. It is an independent agency created by Congress in 1933, after the Great Depression, when thousands of banks failed. The goal was to shore up confidence in the U.S. financial system and protect Americans from losing their cash if their bank failed.

In January 1934, the FDIC began insuring deposits, covering them up to $2,500. That number has increased through the years, of course, most recently with the Emergency Economic Stabilization Act of 2008. President George W. Bush signed the act to temporarily raise FDIC insurance coverage from $100,000 to $250,000 per depositor during the financial crisis. President Barack Obama made the coverage hike permanent in 2010 with the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

It’s important to note how this insurance works: The standard coverage is $250,000 per depositor, per insured bank, for each account ownership category. Joint accounts may be covered up to $500,000.

Related: The Government Takes Decisive Action on Bank Closures

What Does the FDIC Do?

Since its creation, no depositor has lost any money from an FDIC-insured deposit. This means that, unlike your great-grandparents, you can put your money into an eligible financial institution, whether a savings vs. checking account or other qualifying account, and know it’s more secure than stuffing it under your mattress. (Yes, that used to be a thing for many savers.)

Also of note: Though it’s the customers’ money that’s covered by the FDIC, the agency is funded by premiums paid by the banks and from earnings on investments in U.S. Treasury securities. Customers do not pay for this insurance; they are automatically covered when they open an FDIC-insured account.

There are rules and limits you should know about, however, if you want to make the most of the FDIC’s coverage.

Types of Accounts Insured by the FDIC

The FDIC insures all deposit accounts at insured banks and savings associations up to the FDIC’s limits, including:

•   Checking accounts

•   Savings accounts

•   Money market accounts

•   Certificates of deposit (CDs)

•   Prepaid cards when the underlying funds are deposited in an insured bank (these funds are only insured in the instance of bank failure, not loss or theft)

•   Certain retirement savings accounts, but only when placed in certain types of investments and in accordance with all FDIC requirements.

   Deposit accounts, such as checking and savings accounts, money market deposit accounts, and certificates of deposit, can all be held in traditional IRAs and Roth IRAs and are eligible for FDIC insurance.

Recommended: Tips for Overcoming Bad Financial Decisions

How to Tell if Your Money Is FDIC-Insured

How can you tell for sure if your account is covered? While the FDIC insures deposits in most banks and savings associations, not all of them are protected. Every FDIC-insured depository institution must display an official sign at each teller window or teller station, so that’s an easy way to check if you bank at a brick-and-mortar location.

If you’re using an online bank or a mobile-first financial product, the company’s website should contain information about its coverage.

Or you can find out if your deposits are insured by using the FDIC BankFind tool .

Recommended: Comparing the Different Types of Deposit Accounts

Get up to $300 when you bank with SoFi.

No account or overdraft fees. No minimum balance.

Up to 3.80% APY on savings balances.

Up to 2-day-early paycheck.

Up to $3M of additional
FDIC insurance.


Types of Accounts Not Insured by the FDIC

Now, here are the kinds of funds not covered by FDIC insurance. Money held in these ways, even if purchased from an insured financial institution, is not protected:

•   Stocks

•   Bonds

•   Annuities

•   Mutual funds

•   Municipal securities

•   Life insurance policies

•   The contents of a safety deposit box

This is an important point to note as you think about your financial security.

Also, you may wonder about the FDIC vs. NCUA in terms of protecting your finances. The National Credit Union Administration (NCUA), created by Congress in 1970, covers federally insured credit unions in much the same way as the FDIC covers banks, including deposits up to $250,000. If your funds are held at a credit union, you may want to make sure it has NCUA coverage. The FDIC will not be protecting you, but it’s likely the NCUA is.

How FDIC Insurance Works

Here’s more important intel if you’re wondering, How does the FDIC work?

The FDIC covers your holdings in certain accounts, as listed above. What amount of money is insured in a bank account? Usually, the limit is $250,000. It is calculated to cover both principal and interest earned by the depositor. If you have an account that has $200,000 in it and has accrued $20,000 in interest, you will be covered in the amount of $220,000.

As mentioned above, there is a standard $250,000 cap on FDIC insurance. If you have high net worth, this coverage may not be enough. As a result, you may want to keep in mind that by having money in excess of that amount in one bank or one account, you may be putting yourself at risk.

Because the $250,000 applies to each bank where you have an account, one way you may be able to increase the FDIC insurance coverage available to you is by using multiple banks.

Another option is to structure your accounts properly within a single bank. If you have any concerns about your coverage, it can be a good idea to discuss them with a representative at your bank.

Quick Money Tip: Most savings accounts only earn a fraction of a percentage in interest. Not at SoFi. Our high-yield savings account can help you make meaningful progress towards your financial goals.

What Happens if a Bank Fails?

If a bank were to fail, the FDIC would intervene in two ways:

•   The FDIC would pay depositors up to the insurance limit to cover their losses. So, if you had $10,500 in an insured account and the bank failed, you would be reimbursed for that amount. Typically, this happens within a few days after a bank closes.

•   The FDIC also takes responsibility for collecting the assets of the failed bank and settling its debts. As assets are sold, depositors who had more than the $250,000 limit in an insured account may receive payments on their claim.

How to Recover Your Money if a Bank Fails

Because of the FDIC safety net, you won’t likely see fearful customers lining up to get their money the way they did before deposit insurance was established.

Still, when a bank closes, it can cause depositors to worry and wonder how to get their money. Typically, there are one of two scenarios when a bank fails:

•   Most commonly, you would become a depositor at a healthy, FDIC-insured bank. You would have access to your insured funds at this new bank and could likely choose to keep your accounts there if you like.

•   If there is not a healthy, FDIC-insured bank that can step in quickly, the FDIC will likely pay the insured depositor by check within as little as a few days after the bank closes.

As for immediate next steps if you learn your bank is closing, the FDIC aims to post information as promptly as possible, or you can contact the agency at 877-ASK-FDIC or visit the FDIC Support Center website .

The Takeaway

Though it’s quite a rare occurrence, a bank can fail when it takes on too much risk or, as was the case recently, was exposed to interest rate risk. If your bank is covered by FDIC insurance you can receive reimbursement up to $250,000, meaning your funds aren’t lost for good. FDIC insurance covers checking, savings, money market accounts, CDs, and other deposit accounts.

The FDIC does not cover some of the other financial products or services offered by banks, including stocks, bonds, mutual funds, annuities, and securities.

Putting your money in a brick-and-mortar financial institution isn’t the only way to make sure it’s protected. SoFi Checking and Savings is a mobile-first online bank account that keeps your hard-earned dollars safe; all accounts receive FDIC insurance of up to $250,000 per member.

What’s more, we offer an array of great features that can make managing your money easier, such as spending and saving in one convenient place and using savings tools such as Vaults and Roundups. Plus, you’ll earn a competitive annual percentage yield (APY) and pay no account fees, both of which can help your money grow faster.

Want security, convenience, and no account fees? Bank smarter with SoFi.
 

FAQ

How often does a bank fail?

Currently, banks fail very rarely. In the past two years, no banks failed in the United States. However, the FDIC was created in response to thousands of bank failures around the time of the Great Depression.

How does the FDIC differ from the NCUA?

FDIC insurance applies to qualifying accounts at banks. NCUA insurance covers qualifying accounts at credit unions.

How many banks are FDIC insured?

As of September 2022, the FDIC insured a total of 4,746 institutions. Of these, 4,157 were commercial banks, and 589 were savings institutions.

Are credit unions FDIC-insured?

Credit unions don’t qualify for FDIC insurance. Instead, they may be covered by the National Credit Union Administration, or NCUA, insurance.

SoFi members with direct deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2025 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOBK1222032

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Mar
07
2023
Guide to Sales Tax

Guide to Sales Tax

By | money | Comments Off on Guide to Sales Tax

Taxes are inescapable: You likely have income taxes withheld from every paycheck; if you’re a homeowner, you pay your property taxes; and yes, when you tap your card at the register, you pay that additional sales tax.

You may wonder why you have to fork over that extra bit of your hard-earned cash. This guide will help with that. Read on to learn:

•   What is sales tax?

•   How does it work?

•   What are the different kinds of sales tax?

•   How much is sales tax on average and in each state?

•   What are the pros and cons of sales tax?

What Is a Sales Tax?

Sales tax is a form of revenue for state and local governments. States and localities levy sales taxes on certain purchases of goods and services. For every eligible purchase you make, you’ll pay a sales tax — a percentage of the sale price.

State and local governments use the revenue generated from sales taxes to fund their budget. That means your tax dollars could pay for things like libraries, law enforcement, parks, infrastructure, and schools.

States and localities can charge separate sales taxes, though they don’t always do this. Five states currently do not charge sales taxes: Alaska, Delaware, Montana, New Hampshire, and Oregon. Of those five, only one state (Alaska) has cities/counties that charge local sales taxes. States without sales taxes may generate revenue from other types of taxes, like income taxes and property taxes.

How Does Sales Tax Work?

Now that you know what sales tax is, consider this: How does sales tax work? As a consumer in the United States, prices on items in the store typically don’t display the sales tax. You’ll either need to do the math in your head (or using your phone) or wait until you get to the register to see how much you’ll owe in sales tax. When shopping online, e-commerce sites usually tabulate sales tax near the end of the transaction as well.

When you pay for the item (or service), the merchant (or service provider) collects the sales tax owed. Your job as a consumer is finished — but the business must then submit the taxes to the state and local governments. That means it’s on the business, not you, to keep records of sales taxes.

PRO TIP: Although you don’t submit the sales taxes to the government yourself, you may want to keep track of sales taxes paid throughout the year. Why? If you’re itemizing deductions when preparing your tax return, you can take the SALT deduction (sales and local taxes). You can choose to deduct your state and local income taxes or your state and local sales taxes, whichever delivers a bigger tax benefit.

Deductions can help to lower your taxable income and reduce your tax burden. Working with an accountant or using tax software can help you make sure you capture all appropriate deductions.

Types of Sales Tax

While you may be accustomed to thinking of sales tax as a single entity, there are actually three different kinds that you might encounter.

•   General sales tax: This is the amount added to everyday purchases, such as a new suitcase or some beach reads come summer. When most people wonder, “What are sales taxes?” this is likely the kind of surcharge that pops into their head.

•   Excise tax: You may also hear this referred to as “sin tax,” and it’s imposed on cigarettes, alcohol, and gambling, among other goods, activities, and services. These taxes are applied when the government may consider something potentially harmful.

•   Value-added tax (VAT): This is a tax that is imposed at various stages of production when an item or service is created. In the U.S., this tax isn’t levied separately; it’s rolled into the cost of a product. However, you may hear VAT referred to when you travel overseas, where this tax may be added onto the price of goods or services.

What Is the Average Sales Tax Percentage in the US?

The average sales tax percentage in the United States is 6.55% — but this number may not be what you find where you live. To calculate this number, we used 2022 data from the Tax Foundation, but these data points are subject to change as states and cities update their tax code.

In addition, this number represents a combination of the state sales tax and the average local sales tax rate for each state. Though it’s a good representation of local sales tax in a state, it may not be an actual tax rate being charged anywhere.

Here’s a table, based on that same data set, showcasing state sales tax rates, average local sales tax rates per state, and combined sales tax rates for each state and Washington, D.C.

State

State Sales Tax Rate

Average Local Sales Tax Rate

Combined Sales Tax Rate

Alabama4.00%5.24%9.00%
Alaska0.00%1.76%1.76%
Arizona5.60%2.80%8.40%
Arkansas6.50%2.97%9.47%
California7.25%1.57%8.82%
Colorado2.90%4.87%7.77%
Connecticut6.35%0.00%6.35%
Delaware0.00%0.00%0.00%
Florida6.00%1.01%7.01%
Georgia4.00%3.35%7.35%
Hawaii4.00%0.44%4.44%
Idaho6.00%0.02%6.02%
Illinois6.25%2.56%8.81%
Indiana7.00%0.00%7.00%
Iowa6.00%0.94%6.94%
Kansas6.50%2.20%8.70%
Kentucky6.00%0.00%6.00%
Louisiana4.45%5.10%9.55%
Maine5.50%0.00%5.50%
Maryland6.00%0.00%6.00%
Massachusetts6.25%0.00%6.25%
Michigan6.00%0.00%6.00%
Minnesota6.875%0.61%7.485%
Mississippi7.00%0.07%7.07%
Missouri4.225%4.06%8.285%
Montana0.00%0.00%0.00%
Nebraska5.50%1.44%6.94%
Nevada6.85%1.38%8.23%
New Hampshire0.00%0.00%0.00%
New Jersey6.625%-0.03%5.595%
New Mexico5.125%2.71%7.835%
New York4.00%4.52%8.52%
North Carolina4.75%2.23%6.98%
North Dakota5.00%1.96%6.96%
Ohio5.75%1.47%7.22%
Oklahoma4.50%4.47%8.97%
Oregon0.00%0.00%0.00%
Pennsylvania6.00%0.34%6.34%
Rhode Island7.00%0.00%7.00%
South Carolina6.00%1.44%7.44%
South Dakota4.50%1.90%6.40%
Tennessee7.00%2.55%9.55%
Texas6.25%1.85%8.20%
Utah6.10%1.09%7.19%
Vermont6.00%0.24%6.24%
Virginia5.30%0.45%5.75%
Washington6.50%2.79%9.29%
Washington, D.C.6.00%0.00%6.00%
West Virginia6.00%0.52%6.52%
Wisconsin5.00%0.43%5.43%
Wyoming4.00%1.22%5.22%

Again, this table has a lot of caveats: The latest data comes from early 2022. Tax rates are subject to change, and the data has a lot of fine print, which you can find on the Tax Foundation website.

Recommended: Best States to Retire in for Tax Purposes

Why Are Sales Taxes Different in Every State?

Sales taxes are levied at the state and local levels. Because each state is permitted to form its own tax code, sales taxes can vary depending on which state you live in or visit.

In many states, cities and counties can also leverage their own sales taxes.

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How Is Sales Tax Calculated?

To see how sales tax is calculated, let’s look at an example. Suppose you want to buy a new shirt for $20. The combined (state and local) sales tax rate is 7.5%. At the register, you’d pay $21.50. The store keeps its $20, and the $1.50 (7.5% of the sale price) goes to the government.

Here’s that math broken down:

Sale Price

$20
Total Sales Tax Rate

7.5%
Sales Tax Calculation

$20 x 0.075 = $1.50
Total Price

$20 + $1.50 = $21.50

What Kinds of Items Are Taxed?

Almost all goods and services have sales taxes, though there are exceptions. For example:

•   States commonly do not charge sales tax on prescription drugs.

•   Most states don’t charge sales tax on food purchases, either. Those that do may offer a reduced tax amount on food.

•   Though it varies by state, some services — especially digital services — may currently be exempt from sales taxes.

In addition, certain items may have an excise tax, which is different from the typical sales tax rate. Common excise tax goods include alcohol, tobacco, and gasoline.

Worth noting: Many states have sales tax exemptions for Rx and OTC drugs, textbooks, and other items. States may also have sales tax holidays, when certain goods are sold tax-free (such as school supplies during the back-to-school season).

Recommended: Tax-Friendly States for Pensions and Social Security Income

Pros and Cons of Sales Tax

So what are the pros and cons of sales tax? Let’s break them down:

•   Pro: They’re easy to calculate. Compared to income taxes (from estimating tax withholdings to filing a tax return), the process of paying and collecting sales taxes is easy. It’s a flat rate, after all.

•   Con: It puts a heavier tax burden on low-income taxpayers. Income taxes in the U.S. are a progressive system: The more you make, the more you pay. Opponents of higher sales taxes — especially in states without income taxes — argue that this disproportionally puts the burden on low-income earners, since the sales tax rate is the same no matter how much money you have.

•   Pro: Sales tax provides revenue for your state and city. Sales taxes fund things like the fire department, parks, and road construction.

•   Con: Sales taxes take more money out of your pocket. If you already pay income and property taxes, shelling out more money to the government in addition to what you pay when you file your tax return might feel painful.

The Takeaway

Sales taxes are a common way for states and municipalities to generate revenue to fund programs and departments that serve the public. In most states, you pay a sales tax every time you purchase goods and services, though there are exceptions.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.80% APY on SoFi Checking and Savings.

FAQ

Do all states have sales tax?

All but five states currently have sales taxes. The five states without sales tax include Alaska, Delaware, Montana, New Hampshire, and Oregon. In Alaska, however, local municipalities can charge a sales tax.

Are states with zero sales tax cheaper?

States with zero sales taxes may seem cheaper on the surface, but to get a full picture, it’s important to look at the state’s income taxes, property taxes, and overall cost of living. For example, Oregon has no sales tax, but it has the fourth-highest income tax rate.

What is the purpose of sales tax?

States and localities rely on sales taxes to fund services for the public. This might include supporting police and fire departments, parks and recreation, libraries, schools, and infrastructure.

Photo credit: iStock/pixdeluxe

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2025 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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22
2023
Guide to Compound Interest Savings Accounts

Guide to Compound Interest Savings Accounts

By | Growing Wealth, invest, money | No Comments

Whether you are first taking the reins of your financial life or have been managing your money for years, you probably know that compound interest can be a powerful tool in growing your wealth. It can be among the reasons why the money you save today can grow much larger as time passes.

It’s pretty common to hear the advice that you should start saving as soon as possible, especially when it comes to stashing away cash for retirement. It can, however, be challenging to accomplish that with all the other expenses that crop up, from student loan debt to high housing costs to inflation hitting you hard at the supermarket.

But even if you can only save a little, you should start as soon as you can. Because the longer you save, the more time you have to watch compound interest work its magic. Here, you’ll learn all about this important financial force, including:

•   What is compound interest?

•   How does compound interest work?

•   What are types of compound interest savings accounts?

•   What are the pros and cons of compound interest?

What Is Compound Interest?

Compound interest is a method by which interest is added to money on deposit (the principal). To put it simply, compound interest is interest that is earned on the initial principal and the interest that accrues on it. So if you were to deposit, say, $200 in a savings account and it earned interest of $5 in its first month, the next month of compound interest would be accrued on $205, or the principal plus the interest earned.

Compound interest can allow individuals to build savings, as the initial investment and interest payments grow almost like a snowball rolling downhill, getting bigger and bigger.

Recommended: APY vs. Interest Rate: What’s the Difference?

How Does Compound Interest Work?

When talking about interest and how it works, you are likely to hear the terms simple interest and compound interest. Comparing the two can be a good way to illuminate what compound interest is.

Simple vs Compound Interest: What’s the Difference?

Simple interest is when interest is paid strictly on the base amount. Let’s say you were to deposit $10,000 in a bank for one year at a rate of 5%. With simple interest, at the end of the year, you would have the $10,000 principal plus $500 in interest, for a total of $10,500.

With compound interest, however, your money would grow faster. If the interest were compounded daily, at the end of the year you would have $10,512.67, and a year later, you would have $11,051.63, while simple interest would yield a total of $11,000. While it may not sound like a huge difference early on, the results are amplified over time and with ongoing deposits.

Here is a chart that captures the differences between compound vs. simple interest:

Simple Interest

 Compound Interest
Accrues on the principal only Accrues on the principal and interest earned
Always calculated annually Can be calculated at different intervals, including daily, monthly, quarterly, and annually
Interest rates typically are fixed, depending on the institution Interest rates may vary, depending on the account type

Types of Compound Interest Savings Accounts

Remember, a good interest rate for a savings account is important, but so is the way that the interest accrues. If you are looking for what is known as a compound interest savings account, you will likely have an array of options. Among the different types of savings accounts that can accrue compound interest are:

•   Standard savings accounts. These are your basic savings accounts that earn interest and may restrict the number of withdrawals you make per month.

•   High-yield savings accounts. High-yield savings accounts typically pay a significantly higher interest rate than conventional accounts. You may often find them offered by online banks.

•   Premium savings accounts. These typically have higher account minimum requirements to snag a higher interest rate and other services and features.

•   Certificate of deposit (or CD) accounts. Certificates of deposit require you to keep your funds on deposit for a specific term and typically have a fixed interest rate, though there are exceptions to that rule.

•   Money market accounts. These often combine features of a checking and savings account.

•   IRA accounts, or Individual Retirement Accounts. IRA accounts allow you to save money for retirement in a way that is tax-advantaged.

Earn up to 3.80% APY with a high-yield savings account from SoFi.

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The Compound Interest Formula

If you want to get technical, there’s a compounding interest formula you can use to calculate savings account interest:

A = P(1+r/n)nt

Let’s break this down. “A” is the final amount of money you’ll end up with. “P” is the principal, or original amount deposited. The “r” is the interest rate as a decimal, so 0.1 for 10%. The “n” is the number of times interest compounds each year, and “t” is the number of years you’re looking at.

The “n” in the formula above — how often interest gets compounded — makes a big difference. If interest is compounded monthly instead of yearly, for example, that can really change things.

Compound Interest Example

Here’s a hypothetical scenario in which $5,000 is deposited and receives a very healthy 10% interest rate that’s compounded annually. After the first year, the account would earn $500. But starting with the second year, the 10% interest would be calculated based on the new amount of $5,500, not just the original $5,000.

Future Value of $5,000 Deposit Compounded Yearly at 10%

Year

 Investment

 Interest Earned (10%)

 New Balance
1 $5,000 $500 $5,500
2 $5,500 $550 $6,050
3 $6,050 $605 $6,650
4 $6,650 $665.50 $7,310.50
5 $7,310.50 $731.55 $8,042.05
6 $8,042.05 $804.21 $8,846.26
7 $8,846.26 $884.63 $9,730.89
8 $9,730.89 $973.09 $10,703.98
9 $10,703.98 $1,070.40 $11,774.38
10 $11,774.38 $1,177.44 $12,951.82

The numbers add up quickly. After 10 years, the account would be worth around $12,951.82. (If you want to see how this works for yourself, an online compound interest calculator can generate hypothetical results depending on the initial deposit, interest rate, additional contributions, and length of time.)

The Rule of 72

Another simple and helpful formula that might be used to estimate compound interest is known as the Rule of 72. This calculation can allow individuals to look at their rate of return, estimating how long it may take before they double their money (with a fixed rate).

For the Rule of 72, it’s possible to divide 72 by the fixed interest rate. In this sort of calculation, the interest rate percentage would be represented by a numeral — not as a decimal. Say an individual has $1,000 that they want to save at a 3% interest rate. To use the Rule of 72, they might divide 72 by the numeral three to find that it could take 24 years to double the principal at this rate.

The Rule of 72 could be a useful tool when deciding quickly between savings accounts or other financial products that offer different possible returns.

Recommended: Different Types of Savings Accounts

Why Making Additional Contributions Matters

While saving early helps you take advantage of compound interest, so does saving regularly. Say after starting an emergency fund savings account with an initial deposit, you add money each year. That will give compounding interest the chance to grow your funds even further.

Getting results via compound interest doesn’t mean you need to have $5,000 to deposit today. Even small contributions can make a difference. The earlier you start saving and the more time you have, the more of a chance compound interest has to help build your wealth.

To illustrate, let’s revisit the equation above with a smaller hypothetical initial deposit. Let’s say $500 is contributed to a savings account today, compounded annually at 10%, and nothing else was done for 10 years. At the end of that time, the account would have:

A = 500 (1+0.1/1)(1*10)
A = 500 * 1.110
A = 500 * 2.5937424601
A = $1,296.87

But if you wait 40 years, you get a different answer:

A = 500 (1+0.1/1)(1*40)
A = 500 * 1.140
A = 500 * 45.2592555682
A = $22,629.63

That’s quite a jump! And all it took was time.

If you were also to add just $50 a month to that initial $500 contribution, you’d have around $10,860 in 10 years. And after 40 years? You’d have $288,185. Even adding small amounts, especially consistently over time, can pay off, depending on the rate of interest and how often it is compounded.

This type of growth can apply to different kinds of retirement accounts as well.

Pros and Cons of Compound Interest

The pros and cons of compound interest can depend significantly on whether you are earning compound interest or paying it.

On the plus side:

•   Compound interest can help your money on deposit grow more quickly, thanks to its “snowball effect” of your interest earning interest.

•   The sooner you begin saving with compound interest, the longer you have to reap its benefits of helping your money increase.

However, there can be a downside to compound interest:

•   If you are paying compound interest on some kind of debt, you may find it challenging to pay off what you owe since the interest can increase so swiftly.

Making the Most of Compound Interest

Compound interest, on its own, can boost savings. Yet, there are other ways individuals can make more out of this financial strategy.

Saving early and often really matters. Time is compound interest’s “special sauce.” Compounding interest grows exponentially over time. So, the longer an individual can leave their money untouched, the more potential it has to grow.

Try these tactics to increase the power of compound interest:

•   Making additional contributions: Whenever they’re possible, extra contributions add to an individual’s principal (the money that accrues earnings), increasing the total savings on which they’ll gain interest and speeding up their potential financial goals.

Consider a person who tucks away $1,000 for 20 years at a 6% return (compounding annually). At the end of that period, they will have roughly $3,200. If the same person made an additional monthly contribution of $100, at the end of the period they could have over $47,000.

•   Avoiding making withdrawals: Removing money from an account slows the effects of compounding interest, as it reduces the amount of money on which an individual could earn returns.

•   Checking interest and return rates: The higher the rate of the return, the greater the impact it will have on your savings. You may want to consider this factor when choosing savings accounts (or other financial products). The average savings account offers relatively low interest rates — around 0.33% in mid-February of 2023. Looking for a high-yield savings account, where the interest rate can be many multiples of that (say, 13 times higher), can be a smart move.

Stock market investments may offer much higher returns as well, up to an average of 10% to 12%. But keep in mind that there’s always the risk that these investments will lose money, given market volatility.

The Takeaway

Compound interest vs. simple interest is a way to earn interest on your money’s principal as well as the interest itself. It can be a good way to accelerate your savings, especially long-term ones. Many different savings vehicles offer compounded interest; check to see the frequency as the shorter the compounding window (say, daily vs. quarterly), the more your money can grow.

Opening an online bank account with SoFi can be a good way to harness the power of compound interest.With a SoFi Checking and Savings account, you’ll also earn a competitive annual percentage yield (APY) and pay no account fees, all of which can help your money grow faster. Plus, you’ll enjoy the convenience of spending and saving in one convenient place.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.80% APY on SoFi Checking and Savings.

FAQ

How much do people typically make in compound interest?

There is no typical amount that people make in compound interest because there are several variables involved: the principal, the interest rate, how long the interest accrues for, and how often it is compounded. To check specific scenarios, you can use an online compound interest calculator.

Is it better to have simple or compound interest?

If you are depositing money and hoping to have it grow over time, earning compound interest vs. simple interest will help it grow faster. However, if you are paying interest on a debt, simple interest will accrue more gradually and therefore be easier to pay off.

Do all banks offer compound interest savings accounts?

Many banks offer savings accounts with compound interest. It can be worthwhile to check to see how often the interest is compounded: daily, monthly, quarterly, or annually. The more frequent the compounding, the faster your money will grow.

Photo credit: iStock/tzahiV

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2025 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Feb
14
2023
Income Tax: What Is It and How Does It Work?

Income Tax: What Is It and How Does It Work?

By | Financial Independence, money, Terminology | Comments Off on Income Tax: What Is It and How Does It Work?

Every year by April 15, give or take a day, most Americans file their tax returns. Income tax is exactly what it sounds like: Individuals and companies are typically required to pay taxes on their income, or the earnings and profits made during the previous year.

Figuring out the right amount to pay can take some time. When you or your tax preparer fills out your tax forms, you’ll find out if you’ve overpaid your taxes, meaning you’re entitled to a refund, or if you’ve underpaid, which means you’ll owe money to the government.

There are different types of income tax, but the one most people have to file is federal, which is done through the Internal Revenue Service (IRS), a bureau within the U.S. Treasury Department. Depending on where you live, you may also have to pay state or local income taxes as well.

Filing taxes can be confusing and complicated, but read on for a guide that will clarify:

•   What is income tax?

•   What are the different kinds of income tax?

•   How do you know how much you owe in income taxes?

•   How can you lower your taxable income?

What Are Income Taxes?

Income taxes are taxes that are collected by the government on income (aka money) earned by individuals and businesses. This can include salaries, tips, commissions, bonuses, investment income, interest earned, and other sources. Also know that what is an income tax can be assessed by a federal, state, and/or local government Some Americans may only pay federal taxes; others may be liable for those at a federal, state, and local level.

What are income taxes used for once they are collected? Taxes are typically earmarked to pay for public services, provide goods for citizens, and also go toward government needs. Infrastructure is a common use; that means things like building roads, improving education, and the like.

Income taxes may be collected at the federal, state, and local level, depending on where you live.

How Does Income Tax Work?

The amount of income tax you pay depends on how much money you’ve earned in the past year as well as other factors, such as whether you are single or the head of household. First, a bit more about what counts as taxable money:

•   Income that’s taxable includes your earnings from work, rental properties, or money made from stock investments.

•   Certain forms of income that are deemed nontaxable and may not have to be reported on your tax return. Some examples of nontaxable income are child support payments , financial gifts, alimony, and employer-provided health insurance.

The U.S. tax system is progressive, which means the greater your income, the higher your tax rate. The idea behind a progressive system is that people who earn more are able to pay more in taxes. So, depending where you fall income-wise, you’ll be taxed at a different rate.

Currently, there are seven tax brackets, ranging from 10% to 37%. Each bracket corresponds to specific income thresholds and are adjusted each year for inflation.

Tax season revolves around filing Income tax returns each spring. Some details:

•   The typical deadline is April 15, though if that date falls on a weekend or holiday, the date will be moved to the next business day.

•   Those who are self-employed may pay quarterly estimated taxes.

•   You must file your federal income tax return with the IRS, by mail or electronically. In order to file, you must have all the necessary year-end income documents, including those from your employers and financial institutions.

•   The IRS recommends taxpayers file electronically, since it can take six months or more to process a paper return. Electronic files move much more quickly through the system.

When you fill out your tax return and file it with the IRS, you’ll find out if you’ve underpaid and still owe any taxes or if you’ve paid too much and are entitled to a refund. Salaried workers file an IRS Form W-4 with their employer spelling out their tax withholding, or allowances. This indicates how much to set aside from a paycheck for taxes. This number can be changed to help compensate for too much or too little taxes paid out during the previous year.

Quick Money Tip: Direct deposit is the fastest way to get an IRS tax refund. More than 9 out of 10 refunds are issued in less than 21 days using this free service, plus you can track the payment and even split the funds into different bank accounts.

Brief History of How Income Taxes Came to Be

Now that you know what income tax is, here’s a quick look at how it came into being in America. The first federal income tax came about in 1861, as a way to finance the Civil War effort. A year later, Congress passed the Internal Revenue Act which created the Bureau of Internal Revenue, which eventually evolved into today’s IRS. But income tax didn’t have the substantial support after the Civil War and was repealed in 1872.

Federal income tax made a short comeback in 1894, but the next year it was ruled unconstitutional by the Supreme Court. This verdict was based on the grounds it was a direct tax and not apportioned among the states on the basis of population.

In 1909, the 16th amendment to the Constitution was introduced, which would give the government the power to collect taxes without allocating the burden among the states in line with population. It was passed by Congress then, but it still needed to be ratified by 36 states. Ratification of the 16th amendment finally happened in 1913, giving Congress the legal right to impose a federal income tax. This laid the foundation for the tax system as it’s known today.

What Are the Different Types of Income Taxes?

There are three basic types of taxes: taxes on what you buy, taxes on what you own, and taxes on what you earn. Under the umbrella of the latter, or earned income, there’s individual or personal income tax, business income tax, and state and local income taxes. Here’s the differences between them:

•   Individual or personal income tax. This type of tax is imposed on salaries, wages, investments, or any other forms of taxable income a person or household earns. Thanks to deductions, tax credits, and exemptions, most people don’t end up paying taxes on all their income.

•   Business or corporate income tax. This kind of tax is based on business profits, minus the costs involved in doing business. According to the IRS, all businesses except partnerships must file an annual income tax return.

•   State and local income tax. Depending on where you live and work, you may have to pay state and local taxes. Currently, nine states (Alaska, Florida, Nevada, South Dakota, Texas, Tennessee, Washington, Wyoming, and New Hampshire) don’t have a state income tax. Some local governments impose a local income tax on people who live or work in a specific city, town, county, municipality, or school district. Both state and local taxes help pay for a wide range of services like roads, schools , and law enforcement. State and local taxes are generally much lower than federal income tax.

Quick Money Tip: Typically, checking accounts don’t earn interest. However, some accounts will pay you a bit and help your money grow. An online bank account is more likely than brick-and-mortar to offer you the best rates.

How Do I Know How Much I Owe in Income Taxes?

In order to figure out how much income tax you may owe, here are some steps:

•   You’ll want to know your filing status which will determine which tax bracket you fall under. The five filing status choices are single, married filing jointly, married filing separately, head of household, and qualifying widow(er) with dependent child.

•   Once you know how you’re going to file, you’ll need to gather up all your documents detailing your earned income, such as your W-2 and 1099 statements. When you have all of the information about how much money you earned, you can total it up, which amounts to your gross income.

•   The next step in knowing how much you owe in taxes is to calculate your adjusted gross income (AGI). You can do this by taking your total gross income from the year and subtracting any “above the line” adjustments, as they’re known, that you are eligible for. A list of adjustments to income can be found on the Schedule 1, 1040 IRS form and include deductions such as educator expenses, self-employment tax, and student loan interest payments.

Once you’ve got your AGI number, you can then subtract any standard or itemized deductions to get your taxable income amount. Itemized deductions can include charitable donations, paid mortgage interest, property taxes, and unreimbursed medical and dental expenses . An alternative to itemized deductions is the standard deduction option. A standard deduction is a set dollar amount based on your filing status. When you have your taxable income number, you can then pinpoint your tax bracket and determine your tax rate.

Recommended: What Are the Common Types of Payroll Deductions?

Ways to Lower Your Taxable Income

You can reduce your taxable income by taking advantage of any pre-tax savings opportunities available to you. Consider these tips:

•   Take advantage of employer-sponsored retirement plans. Contributions to a 401(k) for example, are made before tax. This removes the contribution amount from your taxable income and can thereby lower the amount of taxes you’ll have to pay for the year. You can also take an individual retirement account (IRA) deduction if you contribute, which can also lower taxes owed.

•   Enroll in a health spending account (HSA) or flexible spending account (FSA) if your company offers them. A health savings account allows pretax contributions to be used for upcoming healthcare costs for employees with high-deductible health insurance plans. If your employer doesn’t offer one, you can open a HSA on your own.

   With a flexible spending account, you’ll need to sign up through your employer. Similar to an HSA, you would make a pretax contribution, but a FSA covers medical and dependent expenses like childcare.

•   Figure out what tax deductions you can claim when you file your return. As previously noted, when it comes to deductions, Uncle Sam allows you to write off a number of expenses, including real estate taxes, certain casualty or theft losses, and donations made to a charitable organization. People who are self-employed can deduct such costs as office supplies, phone and internet costs, and any travel expenses related to work. These deductions can help save you hundreds or even thousands of dollars on your tax bill.

•   Check that your tax withholding is appropriate. As noted above, check your W-4 form, the one you fill out for your employer to let them know how much tax to take out. It may need to be adjusted if you owe a considerable amount of money in April. On the flip side, if you have too much withheld and get a significant refund, you’re basically giving the government an interest-free loan throughout the year. To be sure you’re paying the right amount, be sure your W-4 form is updated if you have a major life change, such as the birth of a child, marriage, divorce, or a significant pay raise.

Recommended: 7 Steps to Prepare for Tax Season

Tips for Filing Income Taxes Correctly

Avoiding mistakes when filing your tax return can help prevent you from missing out on a bigger refund than you claimed, owing more taxes, or triggering a tax audit by the IRS.

Here are some suggestions on how to fill out your tax return when filing whether you’ve done it before or are doing your taxes for the first time:

•   Gather all of your pertinent paperwork and make sure you’re not missing tax forms. You’ll need a W-2 form from each employer, other earning and interest statements, and receipts for any expenses you’re itemizing on your return. Any income and investment interest forms should be mailed or sent electronically to you in January. If you haven’t received them in the mail, you can find and download many of these documents online through your bank, mortgage provider, or payroll company. If you still haven’t received your tax statements or can’t find them online, call the necessary people to get your documents as soon as possible.

•   When filling out your return, make sure your basic information is accurate, such as your name, Social Security number, and filing status. The IRS will also be double-checking your numbers against your tax statement documentation.

•   Take care when disclosing your earned income. Report your financial information exactly as it’s reported to the IRS on forms such as your W-2 and 1099.

•   Sign your tax return. According to the IRS, an unsigned tax return is invalid. If you’re married and filing jointly, in most cases both spouses must sign the form. Filing electronically can help taxpayers avoid submitting an unsigned form by using a digital signature.

•   Consider using a tax preparation software program or having a professional tax preparer do your return. Online software is often fairly straightforward if your situation is pretty simple. However, if your tax return is more involved and complicated, it may be worth it to hire a tax professional. An experienced tax preparer can help ensure your tax return will be filed correctly and on time.

•   Try not to put off filing your taxes until the last minute or you run the risk of missing the tax filing deadline.

•   You can file for a tax extension of six months, but know that any taxes owed are still due on time; it’s the return that can be filed later.

Recommended: 11 Red Flags that Can Trigger a Tax Audit

The Takeaway

Income taxes are a way for the government to collect revenue from citizens and businesses. Besides paying federal income taxes, you may need to also pay state and local taxes. There are ways to lower your taxable income, and doing so can result in paying less when the bill comes due or a bigger refund. Knowing how to file correctly and on time can help prevent any delays in reimbursement checks, late fees, or penalties.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.80% APY on SoFi Checking and Savings.

FAQ

Can I lower my income taxes?

Yes, there are several ways you can lower your taxable income. Participating in employer-supported programs (such as pre-tax contributions to a 401(k), FSA, and/or HSA), taking deductions, and choosing the right filing status are all ways you can help reduce your income taxes.

How can I determine how much income tax I’m required to pay?

You can start by estimating your taxable income. This involves taking your adjusted gross income, or AGI. which is the total amount you report that’s subject to income tax; typically, it’s earnings such as wages, dividends, and interest from a bank account, for example. Then you would subtract any tax deductions or eligible adjustments from that amount. What’s left is taxable income. You would then calculate the appropriate tax bracket percentage based on your income and filing status to figure out your tax liability.

Does income tax improve your money management?

It can. Being organized with your taxes can prevent you from owing a large sum come Tax Day, missing the filing deadline, and potentially paying any interest and late filing penalties to the IRS. If you’re self-employed, putting aside taxes from your earnings and paying your taxes quarterly can also help prevent a potentially large tax bill. And, of course, getting a hefty tax refund can go towards savings, investments, or paying down debt.

Photo credit: iStock/Charday Penn

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SoFi members with direct deposit activity can earn 3.80% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.

As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 3.80% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Separately, SoFi members who enroll in SoFi Plus by paying the SoFi Plus Subscription Fee every 30 days can also earn 3.80% APY on savings balances (including Vaults) and 0.50% APY on checking balances. For additional details, see the SoFi Plus Terms and Conditions at https://www.sofi.com/terms-of-use/#plus.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2025 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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