I've discussed the merits of using high yield savings accounts in the past. At the time, I recommended two banks that I've since stopped using: HSBC and Emigrant Direct. I stopped using HSBC a month or two ago when they dropped their interest rate down to 4.25%. At the time, I moved all my funds to Emigrant Direct which was offering 4.65%. Today, I find out that Emigrant Direct is dropping their online savings rate to 4.55%. That's enough to prompt me to seek out better returns! Thursday, January 10, 2008
High Yield Savings Rates Drop Again
I've discussed the merits of using high yield savings accounts in the past. At the time, I recommended two banks that I've since stopped using: HSBC and Emigrant Direct. I stopped using HSBC a month or two ago when they dropped their interest rate down to 4.25%. At the time, I moved all my funds to Emigrant Direct which was offering 4.65%. Today, I find out that Emigrant Direct is dropping their online savings rate to 4.55%. That's enough to prompt me to seek out better returns! 
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Another factor that people often overlook is the taxes paid on interest income. This type of income - whether from a savings account or money market - is not capital gains. Therefore it is taxed at your marginal (i.e., highest) tax bracket. For my wife and me, our federal marginal tax rate this year will be 33%. Yikes. It's prudent to consider a tax-exempt vehicle for your short-term savings in light of your expected tax rate. For example, Vanguard's taxable money market has a current annual dividend yield of about 4.5%. They also offer a tax-exempt money market fund at about a 3.2% yield. In our case, the tax-exempt fund actually has a higher true return. Though, 3.2% is hardly anything to revel in.
What about putting the extra savings into a Roth IRA (if it's not already maxed out). From what I understand, can't you make tax-free and penalty-free withdrawls of the contributed balance whenever you want? While its in there it could be growing at much >5% (highest savings account - Etrade). With the recent huge correction in the market, it might be an ideal buying time for stocks/mutual funds.
One drawback would be that you don't have immediate access to the capital gains without penalty (have to wait until retirement for that). But when comparing a potential much higher return to a 3-5% return taxed at the marginal rate for savings, it seems like a worthwhile trade since there's still full untaxed access to the Roth contribution balance. Of course, this mostly applies if you're young with higher risk tolerance.
I fully endorse having a Roth IRA. High yield savings accounts are where I park my emergency fund - two different things. I max out my Roth contributions each year but my emergency fund is something completely different - money that's easily accessed that I can use if/when I have an urgent need. You're right about being able to access what you put into a Roth. You can pull that out at any time. The only problem with Roths is that there's an income cap and in a 2 income household, you'll hit it pretty quick (I think it's about $155K for married couples). If you make more than that, you're ineligible.
That's right. The Roth IRA income cap isn't that high (especially if you happen to be lucky enough to have married an attorney!) You can contribute to a traditional IRA at any income level where your investment dollars will grow tax-deferred (advantageous if you expect to be in a lower tax bracket when you withdraw the money than you are now). If you make below a certain amount (higher than the Roth IRA limits), your traditional IRA contributions may be pre-tax. In other words, you can deduct some or all of the contributions from your taxable income.
Vanguard has an excellent educational site:
https://personal.vanguard.com/us/accountty
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