There are two types of people in the world -- people who have faced financial emergencies and people who have not. Talk to those who have faced it, they would tell you nothing but cash in the bank account comes handy when an emergency strikes. Imagine yourself in such a situation, and you would know access to emergency funds should be as simple as walking to a nearby ATM and making a withdrawal.
Now that the coronavirus pandemic has once again put the focus back on having emergency funds and on top of it the discussion around various instruments in which it should be parked, most people would agree having cash in savings bank (SB) account is indeed the safest place to have an emergency corpus. Fixed deposits too are a good option, but premature withdrawals attract penalties. Recent experience shows financial markets cannot be the right choice either as even liquid funds, which most advisors suggest for emergency corpus, gave negative returns for a brief period in March.
If you have made up your mind to keep your emergency capital in the SB account, you should make sure it doesn't stay idle. There is one banking facility that can give you FD-like interest rate, yet SB account-like liquidity - auto sweep FDs.
Most commercial banks offer auto-sweep facilities on the SB account in which an auto sweep FD gets linked to your SB account and whatever excess amount you have in the account gets transferred automatically through a sweep out process to book an FD. These auto sweep accounts with regular surpluses earn quite similar returns as FDs. All you have to do is give standing instructions to the bank for the threshold amount, pick the tenure of auto sweep FDs and opt the method of withdrawal (LIFO or FIFO) through sweep-in facility. If an emergency strikes and you need to dip into the funds parked as FDs, the auto sweep facility will work in reverse. If you have exhausted the amount in a savings account, and still want more, the bank will automatically release required funds from sweep-in FD, but the rest of the amount will keep earning a higher interest rate, unlike regular FDs, which when broken, get credited to the SB account entirely.
Let's understand with an example. If you have Rs 90,000 in savings account and you fix the threshold at Rs 50,000 to open a sweep-in FD, then Rs 50,000 will be in savings account and Rs 40,000 will be swept out to book FD. Now if you make a withdrawal of Rs 60,000, Rs 50,000 from savings account and Rs 10,000 from auto sweep FD will get liquidated, while the balance Rs 30,000 will remain in the FD continuing to earn higher interest. If you had a regular FD of Rs 40,000, you will have to liquidate the full amount to meet the shortfall of Rs 10,000.
Why sweep-in FDs for emergency funds?
Easy liquidity is what makes it a right choice for parking your emergency funds into it. "Emergency funds are meant to be most easily accessible. Therefore, sweep-in FDs as a part of this corpus would help an investor in time of emergency. Multiple options like debit card, net-banking and UPI transfers make sweep-in FDs easy to access," says Santosh Joseph, Founder and Managing Partner, Germinate Wealth Solutions LLP.
But if easy liquidity gives way to reckless spending for you, you will be better off with locking your money in regular FDs. "It can be used as an emergency fund assuming you can exercise self-control and not dip into it for your regular expenses. Without that self-control, you'd be better off using a regular fixed deposit as an emergency fund because it would be slightly less accessible. If you regularly have high liquidity in your savings account, you should use sweep-in FDs to get higher returns," says Adhil Shetty, CEO, Bankbazaar.com.
Know its key features
Not all customers get eligible for sweep-in FDs. Various banks have different eligibility criteria to avail it. The features and terms and conditions may differ as well. Remember that sweep-in FDs come with specific tenures. If you break it before the end of the tenure, although there will not be any penalty, you would lose out on the interest - but only for the amount that has been withdrawn. "If you've created the sweep-in FD for one year at a rate of 5% and you liquidated it in under 30 days, and for that tenure the interest rate was 3%. Then this is what you will earn. These norms may vary from one bank to another, so you should check how your bank penalises premature liquidations of FDs," says Shetty. Besides, check the minimum balance you need to maintain in your account along with various tenures and interest rates applicable.
Modes of withdrawal
Since multiple sweep-in FDs of different tenures can be linked with your savings account, you have two modes - Last in First Out (LIFO) or First in First Out (FIFO) - to make withdrawals. Ideally, LIFO should be preferred because 'last in' would have earned substantial interest, you may choose FIFO if you know you will make frequent withdrawals so that 'last in' stays deposited for a longer tenure to earn high interest.
"In a rising interest rate scenario LIFO method gives you a higher return as new FDs are booked at higher interest rate than old FDs and when withdrawal happens, the old FDs with lower rates are withdrawn first. In a falling interest rate scenario FIFO method gives you higher return. If interest rate is stagnant or range bound then FIFO gives higher return as short term FDs are withdrawn first. Iif an account holder makes frequent withdrawals from the sweep-in facility, then FIFO may be better depending on the frequency of sweep-in and sweep-out in the FD account. In general, the sweep-in facility earns a higher interest with less number of withdrawals," says Archit Gupta, founder and CEO at Cleartax.
As per section 80TTA of Income Tax Act, there is a deduction on savings account interest up to Rs 10,000 per annum. Interest earned beyond Rs 10,000 gets added to an individual's annual income. However, since sweep-in FDs, just like regular FDs, are term deposits, section 80TTA is not applicable to it. Interest earned on sweep-in FDs gets added to your income under the head 'Income from other sources' and taxed as per your slab rate. "At the highest slab, you may end up paying a tax of 31.2 per cent (plus surcharge if applicable) on the interest earned. There is no tax deduction on the interest earned except in the case of senior citizens (60 years and above) who are entitled to a deduction of Rs 50,000. On the other hand, an individual taxpayer less than 60 years of age can claim a deduction up to Rs 10,000 on interest earned from a savings account," says Gupta of Cleartax.
Difference between sweep-in FDs and flexi deposit
Flexi deposits have similar features as sweep-in FDs, which make for the insufficient funds in savings accounts, with the only difference of no auto-sweep out facility. You need to manually book a flexi deposit every time you have surplus cash in your savings account.
Auto sweep FDs automate the process for parking funds at a higher rate and are helpful if you are not comfortable in doing this manually. However, auto sweep FDs come with standard tenures such as one year to five years, on which banks may not be offering their highest interest rate. If you are comfortable booking FDs manually and have online access for instant withdrawal then you can always book your FDs for the highest interest rate tenure.