Sweep Account Meaning, Types, Advantages, & Disadvantages with Example

Last Updated: 27 Dec 2024

Managing finances effectively is often a matter of finding tools that maximise returns and maintain liquidity. Sweep accounts have emerged as a great solution to bridge the gap between earning potential and accessibility. Whether an individual is looking for smarter savings or a business is optimising cash flow, these accounts offer flexibility and automation that fit your financial goals. This guide will help you make informed decisions about integrating sweep accounts into your financial strategy.

Sweep Account Meaning

A sweep account is an arrangement wherein surplus funds in a main account are automatically transferred to a higher-interest investment or savings account. It works on the principle of “sweeping” excess cash over a certain amount into alternatives like money market funds, fixed deposits, or other interest-generating instruments.

This way, idle funds can be used to generate returns while retaining liquidity in the main account. Sweep accounts are common among individuals, businesses, and organisations looking to optimise cash management. They help balance dual goals: maximising returns on surplus funds and meeting the short-term needs of cash flow.

How Do Sweep Accounts Work?

A sweep account “sweeps” money between a checking account and an account that earns a higher interest rate.

When creating a sweep account, you choose a specific amount to retain in your checking account. Only funds in excess of this amount will be transferred at the end of the working day. This excess is transferred to investment options like money market accounts or high-interest savings accounts.

On the other hand, if your checking account balance drops below this level, the funds are reverted back from the investment vehicle to ensure enough funds in your checking account to avoid overdrawing.

Sweep accounts may also be used to repay loans in lieu of earning interest. The procedure remains the same, except that instead of putting the excess funds into an investment account, the excess amount in the checking account is used to repay the loan, thus making your debt payments easier and faster. However, if your checking account falls below a specified threshold, you won’t be able to repay the loan. In that case, you will have to use a line of credit to replenish your funds.

What are the Functions of Sweep Accounts?

Sweep accounts, for business or for personal use, ensure that money is not idle in a low-interest earning account, while it could very well be earning higher interest in distinctly liquid investment vehicles. These investment vehicles include money market mutual funds, high-interest investment or savings accounts, and short-term certificates with maturities ranging from 30, 60, or 90 days.

Some institutions offer an auto-sweep feature, where a sweep account is linked to a regular account and transfers start automatically when certain thresholds, both upper and lower limits, are crossed.

Businesses and individuals should keep a keen eye on their spending via checking accounts. The benefit of higher returns from an investment vehicle outside the checking account can be offset against any account fees charged. Many intermediaries or banking institutions charge a fixed fee, while certain others charge a percentage of your income.

Example of Sweep Account

Imagine you hold a savings account with an Indian bank, and the minimum threshold balance for the sweep facility is set at ₹50,000. If your account balance reaches ₹80,000, the bank will automatically “sweep” the surplus ₹30,000 into a fixed deposit (FD) to earn a higher interest rate.

This ₹30,000 earns FD interest while the remaining ₹50,000 stays accessible in your savings account for daily transactions. If your balance drops below ₹50,000 due to withdrawals, the bank will “reverse sweep” funds from the FD to maintain liquidity.

Types of Sweep Accounts

Sweep accounts come in various forms, catering to diverse financial needs. Here are the primary types:

• Savings-to-Fixed Deposit Sweep Accounts: Excess savings account balances are swept to a fixed deposit, earning more interest. This is helpful for people who want to maximise returns on idle cash but need access to liquidity.
• Business Sweep Accounts: Designed for businesses, these accounts sweep surplus funds into money market instruments or term deposits to optimise cash flow management and short-term investment returns.
• Loan Sweep Accounts: These accounts reduce loan interest by sweeping idle funds to offset outstanding loan balances. It is particularly useful for businesses managing working capital loans.
• Mutual Fund Sweep Accounts:Surplus funds are invested in liquid mutual funds, which typically offer higher returns than a simple savings account. This strategy can be used by risk-averse investors who are looking for near-term returns.
• Debt Instrument Sweep Accounts: Money is swept into debt instruments such as treasury bills and bonds, which provide safety together with predictable returns.

The Difference Between Personal Sweeps and Business Sweeps

A sweep account for individual investors is commonly used to park funds waiting for reinvestment – incoming cash, money from dividends, and sales orders. These funds will generally be swept into high-interest accounts or into money market funds. This continues until the investor makes a distinct future move, or until the broker performs permanent orders in the portfolio.

Sweep accounts are well-known business tools, especially for small businesses that depend on working capital, but also want to maximize the potential of cash reserves. The business establishes a minimum balance for its major accounts, over which money is swept into better investment products. If the balance falls below the threshold, funds have returned to the account.

Depending on the institution and investment, the liquidation process is usually settled daily from the checking account, while refunds may be delayed. As checking account rules differ, some banking institutions also offer higher interest rates on amounts in excess of certain balances.

Advantages of Sweep Account

• Maximise Returns: Idle balances are automatically invested in higher-yielding investments to ensure the optimum utilisation of surplus cash.
• Automation: Saves time and effort due to the absence of manual transfers of funds.
• Liquidity: Enables easy access to liquid funds when needed, hence maintaining flexibility in transactions.
• Cash Flow Optimisation: Helps businesses manage cash flow efficiently by reducing idle balances.
• Interest Cost Savings: The sweep account saves interest paid on loans by sweeping excess funds into a loan.
• Tailor-Made Investments: Different investments, such as fixed deposits, mutual funds, and debt instruments, are offered to cater to various financial objectives and risk-related needs.

Disadvantages of Sweep Account

• Minimum Balance Requirement: Requires maintaining a threshold balance, which may restrict full fund utilisation.
• Low Returns on Short-Term Investments:Some sweeps invest in money market funds, which result in lower returns than other investments.
• Fees and Charges:Banks may charge some fees to activate or avail the sweep facility, thus reducing its overall profitability.
• Tax Considerations: Swept funds’ interest is taxable, so the net returns could be affected.
• Risk of Premature Withdrawal:Fixed deposit sweeps may come with penalties if funds are reverse-swept before maturity.
• Limited Customisation:The options for investment of sweeping funds may be determined by the bank.

Final word

The answer to what a sweep account is describes an account that moves extra funds, if any, between a checking account and a higher interest-earning investment account. This transfer occurs at the end of every business day. Sweep accounts can help you get more value for your (idle) money. The key is finding avenues that match your financial needs and goals.

Frequently Asked Questions

Is it possible to take money out of a sweep account?

Yes, funds in a sweep account are accessible. Suppose the primary account balance falls below the threshold. In that case, the bank reverses the sweep, transferring money from the investment or fixed deposit to the primary account for withdrawal or transaction needs.

Can investors set their investment preferences in a sweep account?

Some banks allow investors to select preferences for sweeping funds, such as fixed deposits, mutual funds, or other instruments. However, these options vary by bank and account type. It’s important to review the bank’s terms for customization flexibility.

Who is eligible to get a sweep account?

Sweep accounts are typically available to individuals and organisations, maintaining the required minimum balance. Eligibility criteria, including account type or income requirements, may vary based on the bank’s policies and the account holder’s financial needs.

Are there any taxes on sweep accounts?

Yes, earnings from sweep accounts, such as interest or investment returns, are subject to applicable income tax. The tax rate depends on the account holder’s income tax bracket and the type of investment chosen for the sweep facility.