Amit maintains a relatively high balance in his savings account. He gets a call from his Bank Relationship Manager that he opt for Auto-sweep facility. RM tells him that he will earn better return than savings account and the money will be readily available when he needs it.
Amit finds the feature interesting and wants to find out more about Auto-sweep facility.
What is Auto-sweep Facility?
If the balance in your savings account exceeds a threshold, the excess amount is converted into a fixed deposit.
And you will get a higher rate of interest in a fixed deposit (as compared to a savings bank account).
If you need the funds in excess of balance in the savings bank account, one or more fixed deposits are automatically broken. In this way, you get a seamless experience. You do not have to worry about opening a fixed deposit or breaking FDs to ensure that you have enough money in your savings account. The bank takes care for you. The fixed deposits are broken in LIFO basis i.e. the last FD is broken first.
Do note banks may have different nomenclature for this product (auto-sweep) and may even have different terms and conditions. ICICI Bank calls it Flexi-FD while SBI refers to it as Savings Plus account. You must go through terms and conditions.
In this post, let’s refer to auto-sweep facility as a Flexi Fixed Deposit.
Points to Note
- You define the threshold above which the excess amount will be automatically swept into a Fixed Deposit.
- You can also define the default tenure of the Flexi-FD. With ICICI, it is between 15 and 91 days while with SBI, it ranges from 1 to 5 years.
- FDs are made in multiples of say Rs, 5000.
- Fixed deposits are broken on LIFO basis. FD opened last will be broken first.
- There may be a penalty for premature withdrawal from FD (breaking of FD).
For instance, you have defined the threshold for auto-sweep as Rs 50,000 in your account. Auto-sweep is done in multiples of 5,000. Your savings account balance is Rs 30,000. Default tenure of Flexi-FD is 6 months.
You deposit Rs 40,000 in your savings account. Now, the balance goes to 70,000. The excess Rs 20,000 (over Rs 50,000) will be swept into a FD. Essentially, the bank will automatically open a Fixed deposit of Rs 20,000 for 6 months.
If you need to withdraw Rs 55,000 next week while your savings account balance is only Rs 50,000 (you are Rs 5,000 short), the flexi-FD will be automatically broken.
It is quite possible that your bank breaks only partial FD i.e. the remaining Rs 15,000 (Rs 20,000-Rs 5,000) continues to earn FD interest. This feature is not available for regular fixed deposits.
A Flexi-FD looks like an excellent product but here are a few things you must know before opting for auto-sweep facility in your savings bank account.
#1 You may have to withdraw prematurely
Premature breaking of a FD entails a penalty. In case of premature withdrawal (breaking of a FD), banks offers you the interest for which the FD was maintained. Additionally, it may also charge you a penalty.
Suppose a flexi fixed deposit was opened through auto-sweep facility for 6 months at a rate of 6.25% per annum. However, the FD had to be broken after just 15 days to honour a cheque, you will get the interest applicable for a 15 day FD, which is say 4.25%. If the bank charges a penalty of 0.5%, you will get only 3.75%. This is lesser than even 4% in savings account.
Contrast this with debt mutual funds. With most debt mutual funds, there is no restriction on withdrawal. You may withdraw any time without any penalty.
However, when it comes to liquidity, flexi FD scores over debt funds. Even redemption from a liquid fund will take one business day to reach your account. With Flexi FD, money is available instantly.
#2 Turnover in your account
If the turnover is your account is high, it is quite possible that the Flexi FD will be broken frequently and you will have to incur penalty often. As discussed above, you may end up earning even less than 4% p.a. This will not always happen though.
You need to consider this aspect if you plan to opt for auto-sweep or flexi FD facility.
#3 Tenure matters in a Fixed Deposit
In a fixed deposit, higher the FD tenure, the better return you get. Suppose you opened fixed deposit for 45 days a month back. There is another fixed deposit you opened for a year. Over the last month, the 1-year FD would have earned you better returns.
This is important because you need to decide the default tenure of your flexi-FD. If you choose a lower tenure, you earn less. If you choose a longer tenure, you risk premature withdrawals and resulting penalty.
In case of a debt mutual fund, vintage of your investment does not matter. It does not matter if you invested 15 days back or 15 years back. Over the last 15 days, both investments will earn the same return.
#4 Taxation is adverse
In case of fixed deposit, you have to pay to income tax on interest income every year. It does not matter if you received the interest in your savings account or not.
Savings account bank interest up to Rs 10,000 per annum is not taxable as per Section 80TTA of the Income Tax Act. No such thing with Fixed deposits.
If you opt for auto-sweep facility and have high turnover in your account, you may end up earning less than savings account interest and may even have to pay tax on it.
If you had put the amount in a debt fund, the tax liability would have arisen only at the time of sale of such MF units. Therefore, if you happen hold to the units for more than 3 years, the tax treatment is quite benign. The resulting capital gains on sale will be taxed at 20% after indexation.
The taxation of fixed deposits and debt mutual funds is quite different and has been discussed in detail in another post.
#5 Compound Interest or Simple Interest?
With a few banks, if the tenure of the FD is less than a certain period, you may earn only simple interest and not compound interest. For instance, with RBL Bank Flexi Sure Fixed Deposits, you earn Simple interest if the FD tenure is less than 181 days.
PersonalFinancePlan Take
Going through the post, you might have felt that I am beating the drum for debt mutual funds. Therefore, I owe a clarification.
A Bank fixed deposit is a simple product and is easy to understand. It is difficult to go wrong with a fixed deposit i.e. you know exactly what you are getting into.
On the other hand, debt mutual funds come in multiple variants. Therefore, you need some skill, time and effort to figure out the right fund for you. It is not difficult to pick up a wrong debt fund.
Flexi Fixed deposit (auto sweep facility) is a good product too. You can get higher returns without compromising on the liquidity. The money in the flexi fixed deposits is always readily available. Therefore, if you are not comfortable with debt funds, Flexi Fixed deposit can be a good product for you. You will get more interest without sacrificing any liquidity unless the turnover in your savings account is too high.
However, personally, I would let only a small part of my savings to go into a Flexi-FD. Only the amount that I need in savings account for regular expenses or any emergency would be left for Flexi-FD. Anything above, I will rather open a regular FD (and have more control) or invest in debt MFs.
For the money that I feel I may not need in 3 years, I would keep that money in debt mutual funds for efficient taxation.
What will you do?
Disclosure
I have not opted for auto-sweep facility in my savings bank account.
Image Credit: Pixabay