Definition of a Passbook Savings Account

Passbook savings accounts provide instant access to funds like a piggy bank.

A passbook savings account specifically refers to the "passbook" that is issued to a saver when opening such an account at a bank or other financial institution. It is a book, the official record of the saver's deposits, withdrawals, interest paid, and the balance on savings and deposit accounts. While rapidly becoming an anachronism due to computerization in the banking industry, some savers prefer this more traditional method of recording their savings transactions for ease and safety.

A Demand Deposit

Passbook savings accounts are demand deposits that are federally insured by the Federal Deposit Insurance Agency (FDIC) or the National Credit Union Administration (NCUA). Financial institutions may or may not require a minimum balance to maintain a passbook savings account. The saver is free to withdraw funds from the account "on demand," at any time. It is the most liquid of savings accounts compared to "time deposits" where the saver commits to not withdrawing funds for a specified period under penalty of an "early withdrawal fee."

Lower Interest Rates

Passbook accounts pay very low interest rates.

Since financial institutions are "uncertain" as to how long they have use of funds in demand deposit accounts for investment purposes, these accounts pay and accumulate the least amount of interest. Thrifts, savings and loan institutions and credit unions typically pay higher interest rates on passbook savings accounts than commercial banks, but even their rates are lower than their other savings products.

Saver Apathy

Many savers maintain passbook accounts for emergencies and convenience, frequently in large amounts and for extended periods of time. They are oblivious or indifferent to better paying savings options. This saver apathy is, of course, a boon for the banks because they pay a very low interest rate while investing the funds in high yield securities and other investments.

The Risk in No-Risk Passbook Savings Accounts

Passbook accounts can be like throwing money down the drain.

Many financial advisers counsel against passbook savings accounts, opining that it is unconscionable to allow money to languish in such low paying savings vehicles. When the effects of inflation are taken into account, passbook savings accounts are, at best, a break-even proposition and frequently present the risk that the saver will actually lose money. According to AmericaSaves.org, American consumers lose $30 to $50 billion annually in low interest savings accounts. Alternative savings products are available that offer equal protection with slightly less liquidity while paying higher interest rates to combat the effects of inflation.

Alternatives to Passbook Savings Accounts

Certificates of deposits (CDs) and money market accounts offer far better interest rates and the same protection as passbook savings accounts. They are FDIC- or NCUA-insured when obtained through an FDIC or NCUA financial institution. CDs are one notch down on the liquidity scale relative to passbook accounts. Money market accounts, however, allow instant access to the cash with no penalty for withdrawals. It is wise to check with the financial institution to learn the specific terms and conditions regarding CDs and money market accounts, before investing, as the terms and conditions will differ by institution.

References

• eLook: Passbook Savings Account Definition
• America Saves.org: Billions Lost in Savings Interest (PDF)
• ChristiaNet: Highest Savings Account Rates