How does interest work on a savings account?

We all want our money to work harder, but if your cash is just sitting in a standard chequing account, chances are it hasn’t reached its true earning potential. Stashing your funds in a savings account is one of the simplest ways to build a safety net or fund your next big milestone—but if you want to truly maximize your returns, you need to look at the math.  

Here is exactly how interest works on a savings account, the difference between simple and compound growth, and how to make them work in your favour. 

Interest 101: How interest works on a savings account

Interest on a savings account is the money an institution pays you for holding money in an account with them. Your earnings are based on the amount of money in the account, your interest rate, and how long the money sits in your savings accounts, among other factors.

There are two types of interest you need to know: simple and compound interest.

• Simple interest only considers the principal, or the original amount of money you deposited into your account. 
• Compound interest is calculated on the principal amount, plus accumulated interest from previous periods. This means that over time, your earnings unlock more money. 

You earn compound interest in a high-interest savings account. The financial provider pays interest into your account based on the compounding frequency. The future value of your account is higher when the compounding period is more frequent—and the math is simpler than it sounds (we promise).

Institutions set savings account interest rates based on financial markets and competition, which is why high-interest savings account interest rates vary so much across providers.

What is APY?

When comparing financial products, you might come across the term annual percentage yield or APY. This is the actual return on your savings once compounding is factored in. Because interest compounds on itself, APY is typically slightly higher than the stated rate. It's the number to look for when comparing savings accounts.

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Capitalizing on compounding interest rates

Compound interest is accrued daily and paid into your account based on the compounding frequency. It’s considered “interest on interest” because compound interest is calculated based on your initial deposit and accumulated interest. If you’re saving for certain goals and want to accelerate your timeline, capitalizing on compounding interest rates can help.

You typically find compound interest in a high-interest savings account, where they benefit from the snowball effect. The longer your money sits and the more frequently you contribute, the faster each compounding period builds on the last. 

Tax implications on your high-interest savings account

One thing to keep in mind: Interest earned in a savings account is treated as taxable income in Canada. It's not tax-sheltered the way a tax-free savings account (TFSA) is. 

Put your savings to work

A Neo Savings account lets compound interest do the heavy lifting—without the risk of the stock market or the contribution limits of a TFSA. Open yours today.

Keep exploring savings accounts:

• What is a high-interest savings account? 
• The best savings account rates in Canada right now
• Chequing vs. savings accounts: Which do you need? 
• The best youth savings accounts in Canada