Savings accounts provide people at every income level with a way to set money aside, whether they’re building an emergency fund or saving for a family vacation. If you’re a credit union member, you won’t earn interest on the balance in your savings account. Instead, you’ll earn dividends. But what are dividends? And how do they differ from interest?
At Addition Financial, we get these questions a lot and it’s important for both current and prospective members to understand the answers to how dividends work. Your dividend earnings can help you to boost your savings and maximize your money. Here’s what you need to know about dividends and what they can do for you.
What Are Dividends?
When you belong to a credit union, you’re a member and a part-owner of the credit union itself. If you have an account at a bank, that’s not the case. You’re a customer. Banks pay interest while credit unions pay dividends, which are the credit union’s way of sharing their profits with members. The power of dividends allows savers to earn money on their dividends, thus compounding their earnings.
Dividend payments vary among credit unions and may vary from account to account within a credit union. It’s common for there to be requirements and restrictions in place for the balance in a savings account (or even some checking accounts) to earn dividends. For example, a high-yield dividend savings account at Addition Financial will typically require a minimum balance of $1,000 to earn dividends. Some accounts, such as our Growth Plus Money Market account, allow account holders to earn dividends that increase as they achieve new tiers of savings.
What is the Difference Between Dividends and Interest?
Both dividends and interest allow account holders to earn a return on savings. Both are typically variable, meaning that the rates can change based on economic factors and the performance of the indices used to determine interest rates. Most often, dividends and interest are compounded daily and earnings are added to your account each month. Make sure you understand how and when interest is being compounded, since some accounts may be compounded monthly.
The primary difference between the two is that interest is paid by banks while dividends are paid by credit unions. Dividends represent a member’s share in the profits of the credit union. It’s often the case that dividend percentages are higher than interest rates on savings accounts, so it’s possible to earn more with a high-yield savings account (HYSA) from a credit union than with a bank account.
It’s important to note here that credit unions do use the term “interest” when they provide loans, including mortgages and car loans. When they are acting as a lender, the term dividend is not correct. Just as credit unions often offer higher dividend rates than banks, they also often have lower interest rates on loans.
Are There Different Types of Dividends?
When we talk about credit union dividends, we may be referring to more than one type of payment to credit union members.
Regular Dividends
Regular dividends are what credit unions offer in lieu of interest on certain savings and checking accounts. This type of dividend works in the same way as interest would if you had a bank account. You may earn dividends if you meet the qualifications to earn them. For example, having a $50 balance in our Share Savings account qualifies you to earn dividends, but the requirement is a minimum $1,000 balance in our Money Market account.
Most credit unions compound dividends of this type daily and credit them to accounts on a monthly basis. In this way, dividend-bearing accounts are similar to interest-bearing accounts because they work in the same manner.
Bonus Dividends
In addition to regular monthly dividends being added to your savings account, some credit unions also pay bonus dividends after they’ve calculated their retained earnings, aka their annual profit. This type of dividend payment occurs only once and is credited to your account.
You’re not guaranteed a dividend payout of this sort. Your credit union may not have enough profits to justify bonus dividend payments. They also have the right to choose which types of accounts qualify for a bonus dividend.
How Can I Use Dividends to Increase My Savings?
If you’re interested in saving more money, then you may be wondering how to earn interest on savings—or dividends, if you’re a credit union member. There are a few key ways that having a dividend-bearing account can affect savings. Here are some of the benefits of dividends.
Your Money Won’t Stagnate
Dividends increase your savings because they represent one of the easiest ways to put your money to work. If you put your savings into an account that didn’t pay dividends, it would never increase. Your balance of $1,000 would stay at $1,000 until you either made an additional deposit or withdrew money from your account.
With dividends, your money is always growing. Provided that you maintain the minimum required balance to earn dividends, you’ll see your balance increase every month. It might be only a small amount at first, but over time you can see significant growth.
You Can Take Advantage of Compounding Dividends
We’ve already mentioned that dividends you earn on your savings account compound daily and are credited to your account monthly. What that means is that you’ll be earning dividends every day. It may be helpful to look at an example.
Let’s say you have a balance of $25,000 in an Addition Financial Growth Plus Money Market account and you’re earning dividends at an annual dividend rate of 2.5%, which is the rate for balances between $10,000 and $99,999 as of January, 2024. Here’s what your earnings would look like in the first month:
- Every day, you would earn $25,000 X .0000685%, or $1.71
- Over the course of a month, you would earn $51.30
- After dividends are added, you’d have a new balance of $25,051.30
- In the next month, you’d earn dividends on your new balance, which would come out to almost $1.72 per day or $51.48 per month
At the end of the year—assuming you made no additional deposits or withdrawals—your new balance would be $25,633. That works out to an annual percentage yield of 2.53%, with the 0.03% representing the power of compounded earnings. That might not seem like much, but if you continued to add to your savings and left your money in the account, your earnings would continue to increase every year, giving you a steady return on your investment.
How Can Dividends Contribute to My Overall Financial Strategy?
Your overall financial strategy should include everything from short-term savings to long-term life planning for things like buying a home, sending your kids to college and planning for your own retirement. Earning dividends on your savings has the potential to contribute to each of these goals.
Let’s start with the big picture. Regardless of what your goals are, there’s always a benefit to having passive income. When you earn dividends on your deposits, your money is working for you every day, even if you’re sleeping or sick or on vacation. That’s one of the biggest benefits of compounding dividends. You’ll always be earning money.
Here are a few specific ways that keeping your money in a dividend savings account can help you with various aspects of your financial strategy.
Building an Emergency Fund
We believe that everybody should have an emergency fund with enough money to pay for a minimum of six months’ worth of regular expenses, including your rent or mortgage, car payment, utilities, groceries and more. When you put your savings in a dividend-bearing account, you’ll get a boost from your monthly dividend payments that will help you reach your savings goal quickly and add to your savings regularly.
Saving for a Large Purchase
A lot of us have financial goals that involve saving for a large purchase such as a down payment on a new car or a house. Choosing a dividend-bearing savings account can help you save money and take advantage of compounding dividends to reach your goal as quickly as possible. If you’ve been keeping your savings in a traditional savings account, you may want to consider moving them to a money market or high-yield savings account to maximize your earnings.
Keeping Your Retirement Savings Accessible
Almost everyone who has a 401(k) or IRA will eventually be required to take mandatory withdrawals by the time they reach the age of 72. Even if you have an annuity or other sources of income, you’ll need to take withdrawals. With a dividend-bearing account, you’ll have someplace to put that money where it can continue to earn money and grow. Choosing a high-yield account will ensure that your money is liquid while still earning passive income that you can use later in retirement if you need it.
Reinvest Dividends
Dividends can add to your savings and you can take advantage of daily compounding to add to your balance. The alternative is to take your earnings and invest them into a vehicle with higher returns. For example, you could take your monthly earnings and contribute them to your IRA or buy additional stocks within an investment app.
Grow Your Savings with Dividends
Joining a credit union and opening a savings account that pays dividends isn’t a replacement for investing. That said, it is a good way to put your money to work and take advantage of compounding dividends to grow your savings. If you have enough money saved to qualify for the highest dividends, you can add a significant amount to your balance every year.
Are you looking for a dividend savings account to help you maximize your savings? Addition Financial has many options that might be right for you. Click here to review our personal savings accounts and choose the one that will help you earn the most money on your deposit!
