Why a 4.5% savings plan pays less than 4.5%
Monthly savings plans and lump-sum deposits at the same rate earn very different amounts. Here is why.
The same $7,200, two ways
Put $300 a month into a two-year savings plan at 4.5% and you pay in $7,200. With simple interest, which most banks use for fixed-term savings, you earn $337.50 and collect $7,537.50 at maturity. Put the same $7,200 into a two-year deposit at the same 4.5% on day one and you earn $648.00, almost twice as much.
Nothing is wrong with the plan. The rate is a yearly rate on the balance, and a monthly plan's balance starts at $300 and only reaches $7,200 at the very end. On average the money is in the account for about half the term, so it earns about half the interest.
How the interest is counted
For a deposit, simple interest is P × r ÷ 12 × n: $7,200 × 0.045 ÷ 12 × 24 = $648.
For a monthly plan paid at the start of each month, the first $300 earns 24 months of interest, the second 23 and the last one month. Adding them up gives A × r ÷ 12 × n(n + 1) ÷ 2: $300 × 0.00375 × 300 = $337.50. The n(n + 1) ÷ 2 is the sum 1 + 2 + … + 24.
Compounding monthly adds a little: $347.41 on the plan and $676.73 on the deposit over two years. The savings interest calculator shows both methods and the working.
Tax on interest
Interest is usually taxed. In South Korea banks withhold 15.4% at payment (14% national and 1.4% local tax); in the United States interest counts as ordinary income and is taxed at your marginal rate when you file; many countries offer tax-free or tax-favored accounts. As an example, a $10,000 one-year deposit at 4.5% earns $450, and a 22% tax leaves $351, an after-tax return of 3.51%.
Enter your own rate in the tax field to see the amount you actually keep.
Comparing offers
When a bank advertises a high rate on a monthly savings plan, compare what it really pays with a deposit or a high-yield account at a lower headline rate. A 6% monthly plan earns about what a 3% deposit earns on the same total, because the average balance is half as large. Also check whether the rate applies to the whole balance or only up to a limit, whether early withdrawal cancels the bonus rate, and whether interest is paid monthly or at maturity.
When a monthly plan is still the right choice
If you do not have the lump sum, a plan is how you build it, and its fixed monthly payment turns saving into a habit. The point is only to read its rate correctly: it is a rate on a balance that grows, not on everything you pay in.
Effective rate: a fair way to compare
To compare a savings plan with a deposit, divide the interest you keep by the average balance and the years. The plan above keeps $337.50 on an average balance of $300 × 25 ÷ 2 = $3,750 over two years, roughly 4.5% a year, the rate it advertises. The deposit earns 4.5% on the full $7,200. Both are correct; they are rates on different amounts. The calculator prints this effective yearly return after tax so plans and deposits can be compared on the same footing.
In short
A savings plan's rate applies to a balance that starts small, so it earns about half of rate × total paid in. A deposit earns the full rate on the whole amount. Compare offers by the interest you keep after tax, relative to the money that was actually in the account, and read the conditions for bonus rates and early withdrawal.