Bank Smart. Don’t let money idle in savings accounts

Do you have funds idling away in savings accounts? In spite of the RBI de-regulating interest rates on savings account years ago, most banks still offer only the standard 4 per cent. You can push up your returns by either investing the surplus in liquid funds or opting for an automatic ‘sweep’ facility that moves excess money from your savings account into a fixed deposit. Here’s a look at each of these options.

Liquid funds invest primarily in money market instruments such as certificates of deposit, treasury bills and commercial paper. These funds have no lock-in period and do not carry entry or exit loads. The risk rate is also lower than other debt funds as they go for short-term investments with maturity up to 91 days.

That said, the risk in liquid funds — as they are market-linked — cannot be avoided. Bank accounts score highest on safety, with investments of up to ₹1 lakh covered by deposit insurance. But if you are willing to take a slightly higher risk, liquid funds can offer better returns.

By actively managing these funds, they have delivered 7-8 per cent returns annually over the last five years, while savings banks have offered 4 per cent. But there is the tax aspect to consider.

For investors looking at liquid funds for a period of less than three years, their returns will be taxed at the income tax slab rates. Savings accounts score better on the tax front; interest up to ₹10,000 is exempt under Section 80TTA of the Income Tax Act.

But even assuming 7 per cent return on liquid funds, post-tax returns work out to 6.3 per cent, 5.6 per cent and 4.8 per cent respectively for individuals in the 10, 20 and 30 per cent tax bracket. This is higher than the 4 per cent that most banks offer.

A few banks — YES Bank, Kotak Bank, IndusInd Bank and Lakshmi Vilas Bank — offer a higher 6 per cent interest on high-value deposits. For instance, Lakshmi Vilas Bank offers 6 per cent for deposits of over ₹5 lakh, whereas Kotak Bank offers the same rate on deposits over ₹1 lakh.

If you fall into a higher tax bracket of 20 or 30 per cent, then deposits offered by these banks may be a better option. But remember that the tax exemption on interest is only up to ₹10,000. If you hold over ₹2,50,000 in savings accounts, liquid funds would still offer better returns.

If you decide to invest in liquid funds and can afford to lock in the money for three years, and are not particular about periodic cash flows, then opt for the growth option rather than the dividend option. All payouts suffer dividend distribution tax of slightly over 28 per cent under the dividend option.

Bottomline: If you plan to park large sums of surplus money, liquid funds offer better post-tax returns.

The other way to earn higher return from your surplus is to invest in FDs for less than a year. Bank FDs with a tenure of up to one year today offer 7.75 to 7.9 per cent (best rates). These may be comparable to returns from liquid funds on a post-tax basis, but should you need the money before maturity, you will be charged a penalty for premature withdrawal.

Liquid funds allow you to exit investments without such penalties.

But there is another option too — an automatic ‘sweep’ facility. This can help move surplus money from your savings account into a fixed deposit, earning you higher returns without compromising on liquidity.

This is because, in case of a shortfall, money can be moved back to your savings account. However, you need to understand the fine print of each bank’s reverse sweep facility before choosing this option.

While you can set the sweep limits for your savings accounts, banks specify a certain minimum threshold above which they will offer this facility. ICICI Bank’s Money Multiplier Plan, for instance, allows you to transfer surplus money from the savings account, subject to a minimum of ₹10,000. HDFC Bank’s SavingsMax sets a minimum limit of ₹1.25 lakh, above which money (₹25,000) is transferred from your savings into your FD.

Axis Bank’s Encash 24 sweeps money into the FD when balance in your savings accounts crosses ₹25,000. Both ICICI Bank and Axis Bank have a lower threshold limit which ensures that you earn maximum possible returns on your surplus money.

You also need to know the tenure for which the FD is created. Axis’ Encash allows you to choose between six months and five years, while HDFC creates a fixed deposit for a one-year and one-day period. Since rates vary across tenures, flexibility to choose the type of FD can also make a difference to your returns. Then, there are penalty charges on premature withdrawal to reckon with.

Hence, if you choose a sweep facility, you must go through this laundry list of conditions. With liquid funds, you will have to initiate a transfer each time you want to move surplus into the fund. With the sweep in, the process is automatic.

Bottomline: If you want to automate transfer of surplus, go for the sweep facility, but after reading the bank’s terms and conditions.