What is a Sweep Account – Its Examples, Benefits and How to Open One?
Often we put money in our savings or a brokerage account that remains unused for a long time and does not earn any returns. A sweep account transfers the unused money to a high interest earning investment option during the closure of each business day.
Sounds interesting? Keep scrolling to learn more about the types of sweep accounts and how they work.
What is a Sweep Account?
As the name implies, a sweep account ‘sweeps’ or transfers excess funds from one brokerage or bank account to another. Such accounts automatically transfer money exceeding a certain threshold limit to a higher interest-earning investment account. This transaction takes place at the end of every working day.
Usually, this surplus cash is transferred into a money market fund. A sweep account also helps lower the chances of cash drag by using higher-interest accounts. Depending on the type, a sweep account can transfer money within the same institution (internal sweep) or another (external sweep).
How Do Sweep Accounts Work?
A customer receives better interest in using the automatic mode of sweep accounts. In addition, the surplus amount is automatically transferred by the end of the working day. This makes it a hassle-free process for customers.
To create a sweep account, traders must set a threshold limit in their checking account. When the account balance exceeds this threshold limit, a ‘sweep transfer’ takes place. In addition, one must create another account, which acts as a destination for these sweep transfers.
Investment options like higher interest savings or money market accounts serve well as sweep accounts. Sweep accounts also come in handy for easy and faster repayment of loans. Here, the surplus amounts help to repay loans instead of adding them to investment accounts.
So, what happens when your checking account balance falls below the threshold limit?
In scenarios like this, the sweep account system will sweep in the low value from the investment account to your checking account.
Also Read: Nostro Account: Meaning, How it Works and Advantages Explained with Examples
Types of Sweep Accounts
Based on the functions, we can classify sweep accounts into the following:
1. Money Market Sweep Account
You can invest the surplus balance of your checking account in a money market sweep account and increase your earnings. When the balance in your checking account falls below a limit, funds from your sweep account will automatically be transferred into the checking account.
2. Loan Sweep Account or Credit Sweep Account
This type of sweep account enables faster repayment of loans using the surplus amount in your checking account. Therefore, a loan sweep account is of great help for business owners to clear off their debts with timely repayments.
How to Open a Sweep Account?
The procedure to open a sweep account may vary from one bank to another. However, the following are some general steps for investors opting for a sweep account:
- Step 1: Know whether your bank provides a brokerage sweep account facility.
- Step 2: If you do not have a brokerage account, create one online with a bank that offers a sweep facility. This will function as your checking account.
- Step 3: Set up a threshold limit. Any balance beyond this limit will be moved to sweep accounts.
- Step 4: Set up the purpose of your sweep account. This will decide whether you will invest in money market funds or repay your firm’s debts.
- Step 5: Study the fine print of your sweep account properly. It will contain the threshold limit and other vital information. You should also look for the expense ratio of your sweep account if you are investing in money market funds.
What are the Functions of Sweep Accounts?
Sweep accounts are of great help for both business and personal use. It ensures your extra money does not stay idle in just your savings account. Instead, they are transferred to accounts with higher interest rates.
Find the functions of sweep accounts below:
- A sweep account ensures steady cash flow and balances of businesses.
- It transfers the additional amount to sweep accounts and prepares it for money market trade.
- Auto sweep accounts link a sweep account with a regular account, and a transfer takes place whenever the balance reaches the threshold limit.
- When there is a shortage of funds in the main account, a sweep account can transfer the insufficient amount to the checking account.
- It allows quick transfers at the end of every working day, so active traders do not have to wait for days for money transfers.
- A sweep account can be an excellent tool for risk management if you can predict the market well. For example, you can sell some high-risk investments and transfer the funds to a sweep account on sensing a potential fall in stocks.
Benefits of Sweep Account
The benefits of sweep accounts are as follows:
- Auto sweep account deletes the extra struggle of customers who would otherwise need to visit banks to make regular transfers.
- The savings account will always stay up to date with the threshold limit owing to sweep accounts.
- One can benefit from high-interest accounts with sweep accounts.
- Small businesses can use sweep accounts to pay off their loans.
- The surplus amount in a savings account is put to good use with sweep accounts.
- Investors can quickly liquidate their sweep account investments.
Illustrating Sweep Account with an Example
Let’s again take Rahul’s sweep account example to understand how they work.
Rahul has a savings account of Rs.20,000 with a 4% interest rate. He also opened a sweep account and set a Rs.30,000 threshold limit on his savings account. Since the current balance in Rahul’s checking account is below Rs.30,000, there is no transfer from his checking account to his sweep account.
Rahul deposited Rs.40,000 to the checking account on July 31. This changes his current account balance to Rs.60,000. A sweeping transfer will occur if his current balance exceeds the threshold value.
To evaluate this surplus amount, the sweeping system takes the difference between the current balance in his checking account and the threshold limit into consideration. The extra amount of Rs.30,000 fulfils the sweeping purpose.
If Rahul withdraws Rs.40,000 from his savings account, his account balance will drop to Rs.20,000. Since it is Rs.10,000 less than the set limit, there will be a sweeping transfer from Rahul’s investing account to his checking account.
Difference Between Personal Sweeps and Business Sweeps?
As the name suggests, personal sweep accounts are for individual use. In contrast, business sweep accounts are for companies and businesses.
A personal sweep account allows the owner to park funds until he decides on further reinvestments. The owner may conduct a ‘sweep transfer’ to a money market fund to earn better interest than usual accounts.
Companies usually have much larger cash flows and need to use business sweep accounts. These businesses keep a minimum limit on their checking accounts. The sweeping occurs when the amount rises above it. This exceeding amount can also be used to repay debts. Even when the market is down and cash reserve falls short, money from a sweep account can be a saviour.
Things to Consider Before Opening a Sweep Account
Remember to consider these points:
- There may be additional charges for investing money in sweep accounts. Therefore, read the terms and conditions carefully before investing here.
- Sweep accounts also come with penalties for premature withdrawal. Due to these penalties, sometimes returns from sweep accounts can be lower than your savings account.
- Many sweep accounts do not include commission charges. However, brokerage accounts that deal with ETFs and bonds, including brokerage sweep accounts, might levy some costs.
- Opt for professional financial advice about the pros, cons and penalties on early withdrawal while signing in for a sweep account.
Also Read: Zero Balance Account – Eligibility, Features and Benefits
Final Word
Sweep Accounts are a convenient way to use surplus amounts sitting idle in a low-interest earning account. Many banks and financial institutions offer auto sweep features. This enables automatic transfer from a checking account to a sweep account at the end of a business day. Thus, taking off the owner’s stress of missing a transfer.
However, like every banking system, sweep accounts have pros and cons. So, investors must do their homework on penalties and seek financial advice before opening a sweep account.
FAQs
Ans. To open a sweep account, you need a premium account with a quarterly or minimum average balance ranging from Rs. 25,000 to Rs. 1 lakh. You are also eligible for a sweep account if you have a minimum fixed deposit of Rs. 25,000. However, these values vary from one financial institution to another.
Ans. Some extra fees might be charged for sweeping money from checking accounts to sweep accounts. In addition, you may face penalty charges when making a premature withdrawal from sweep accounts. Since sweep accounts are special facilities that some banks offer, costs to maintain these accounts are usually high.
Ans. Sweep accounts require a minimum balance for their activation. However, you can open a zero balance account without making any initial deposit to activate it. A sweep account helps to invest the surplus cash. At the same time, a zero balance account strengthens cash balances from other accounts.
Ans. Sweep Accounts hold dividend payouts and new deposits waiting for reinvestment. It also reinvests surplus funds from your checking account and gains when you sell your securities.
Ans. When funds in your checking account run lower than the threshold limit, a transfer occurs from the sweep account to the former. This facility is known as sweep-in.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
