Tiered-Rate Accounts: Examples of How They Work

What Is a Tiered-Rate Account?

A tiered-rate account is a bank account that pays different rates of interest, depending on the amount of the funds held in it.  It can be any type of account but usually is either a money market or a savings account.

Generally, tiered-rate bank accounts will offer higher rates of interest for larger balances, in order to encourage customers to save and remain loyal to the bank in question. They also free the depositor from having to commit their funds for a specific term to get a better rate, as one must with a certificate of deposit (CD), for instance.

How Tiered-Rate Accounts Work

Tiered-rate accounts work by offering different, or "tiered," rates of interest for different levels of account savings, escalating the rates with higher balances.

For instance, a bank might offer five fixed-interest-rate tiers on its money market account, all linked to how much you deposit initially. The lowest tier, or interest rate, is for balances $0 and $2,500. Then, once you get into more significant four figures, the interest rate jumps 0.05 percentage point. It increases another 0.05% for five-figure balances, and one more for balances that crack the six-figure barrier. And if you keep $500,000-plus in the account, you score the highest interest rate of all.

Other banks might tether their interest rates to a reference rate or benchmark, offering larger spreads for the higher account balances.

For instance, a bank might offer a particularly high interest rate for accounts with frequent monthly transactions. In this situation, the bank is betting that it will generate enough fee revenue—if your daily balance falls below the minimum, or you exceed the number of allowable transactions—to offset the higher interest paid on the account. 

Special Considerations

Tiered-rate accounts are designed to attract larger depositors and to encourage existing account holders to deposit larger sums. When it comes to five- and six-figure deposits, banks know they are competing with financial services firms and investment management companies, and with low-risk investment options like money market funds or government bond funds. So they have to offer returns at a comparable level.

Ultimately, however, the main source of business for commercial banks is the practice of lending out the money deposited by account holders. If default rates are low and the bank can earn a higher rate of interest on their loans than they pay to their account holders, then the bank will be profitable.

In this context, banks need to balance the need for attracting customers on the one hand while maintaining their own profitability on the other. For this reason, it is very unlikely that the interest rates offered by a bank will come close to matching the interest rates charged on their loans—unless the fee schedule associated with that account is particularly expensive.

Example of a Tiered-Rate Account

Emma is a longstanding customer at XYZ Financial, a national bank with several branches in her home city. One day, she receives a notice from XYZ indicating that the bank is offering a new savings account with a tiered interest-rate structure.

Under the terms of this tiered-rate account, depositors are entitled to escalate interest rates on their deposits depending on the amount of money held in their account. Rather than providing fixed interest rates, however, XYZ offers variable rates calculated based on a spread against the prime interest rate.

For instance, for deposits between $10,000 and $50,000, XYZ offers a rate of prime plus 0.25% as the account's annual percentage yield (APY); for deposits between $50,000 and $100,000, the rate is prime plus 0.50%; for deposits between $100,000 and $500,000, the rate is prime plus 0.75%; and lastly, for deposits above $500,000, the rate is prime plus 1%.

Emma reasons correctly that this new incentive program is likely an effort by XYZ to attract and retain customers, particularly those with relatively large account balances. Moreover, she recognizes that the bank is likely able to lend out these deposits at higher rates of interest in order to maintain a positive net interest margin. Additional transaction fees and monthly charges implied in the offer add another source of revenue for the bank.

The Bottom Line

A tiered-rate account is a bank account, either checking, savings, or money market, which pays differing rates of interest based on the amount of funds held in it. Usually, tiered-rate bank accounts will offer higher rates of interest for larger balances to encourage customers to save more and remain loyal to the bank.

Banks need to balance attracting customers with maintaining their profitability. So it is very unlikely that the interest rates offered by a bank even for high-value tiered-rate accounts will approach the interest rates charged on their loans.