Savings account interest rates falling? You can consider sweep-in FDs
Private lender Kotak Mahindra Bank on 25 May cut its savings account interest rate. For an account balance above ₹1 lakh, the rate was cut to 4% from 4.5%, while on a balance of less than ₹1 lakh, the rate was cut to 3.5% from 3.75%.
The bank was offering 6% on balances above ₹1 lakh as recently as March. Other banks have also been cutting rates rapidly over the past two months. The State Bank of India (SBI) had cut the rate on all its savings accounts to 2.75% in April.
Interest rates on savings accounts, as well as fixed deposits, have been falling as the Reserve Bank of India (RBI) has been cutting policy rates.
As interest rates on savings accounts fall, depositors should consider moving some money to sweep-in fixed deposits (FDs).
How sweep-in deposit works
A sweep-in FD is a fixed deposit that is linked to your savings account. It pays a higher rate of interest than savings bank accounts—the same as other FDs. For example, a 365-day FD in Kotak Mahindra Bank will pay 5.25% compared with 3.5-4% on the savings account. However, you can also spend money from the sweep-in FD as per your needs. This is possible because of the sweep.
Say your savings account has a balance of ₹5,000 and your sweep-in FD has a balance of ₹1 lakh. For some reason, you need to spend ₹20,000 for some purchase. You can go ahead and transact. The excess ₹15,000 over and above your savings account balance of ₹5,000 will flow into your savings account from the sweep-in FD. For such premature withdrawal, you will get the applicable interest rate depending on the amount and tenure (the number of days for which the FD was maintained).
Why not traditional FDs?
Banks charge a penalty for premature withdrawal, which could be the interest rate on the FD minus 1%. Breaking the FD may also need you to visit the branch, which stops you from spending the money right away. In sweep-in FDs, there is no penalty. In addition, some banks also offer a sweep-out facility, which automatically transfers balance above a specific threshold into a sweep-in FD.
So what should you keep in mind? According to Adhil Shetty, CEO of Bankbazaar, if you have a lot of transactions in your savings account or salary account, linking it to a sweep FD can make calculating returns and income for tax purposes extremely complicated. Only put an amount that you are reasonably sure you will not need for regular expenditure. Second, if there are multiple sweep FDs, check the order in which the bank breaks them. Is it first in first out (FIFO) or last in last out (LIFO)? The latter category is typically more beneficial because this allows older FDs to continue to their actual maturity date. Third, you are getting special FD rates such as the senior citizens rate, check if this is applicable to the sweep-in FD. In other words, a regular FD may offer you a higher rate as a senior citizen, but a sweep-in FD might not.
Are there other options?
If you have a high risk appetite, Rushabh Desai, a Mumbai-based financial planner suggested liquid funds. These can offer slightly higher returns than savings bank accounts. Their returns are connected to yields in the short-term debt market (currently around 5-6%). But these returns are not guaranteed and are subject to market risk. Unlike fixed deposits, tax deducted at source (TDS) is not levied on capital gains in such funds. However, opting for dividend plans of such funds will incur TDS at 10% on dividends above ₹5,000 per year.