What is a sweep account, and how can it optimize your cash management?

In today's economic landscape, leaving excess cash in traditional bank accounts can lead to a loss in purchasing power due to inflation and rising costs.

Sweep accounts offer a solution to this problem, allowing you to earn interest on money you're not actively saving or investing. Here's what you need to know about sweep accounts and how you can use them to optimize your cash management strategy.

What is a sweep account?

A sweep account is a financial tool that automatically transfers excess cash from a primary account into a higher interest-earning account at the end of each business day. This process is similar to setting up automated transfers from checking to savings, but with the potential for higher returns.

Martin Matthews, co-founder of M Wealth Group, explains: "A sweep account is a way to push some of the money sitting in a checking or savings account into accounts that earn a higher interest rate — this is done automatically. It also acts as a layer of protection. If you have a lot of cash sitting in your checking account, and your main account gets compromised, that person now has access to those funds. Whereas, if you sweep the cash into a separate account, there are some buffers and barriers."

Types of sweep accounts

There are several types of sweep accounts, each designed to meet different needs:

• Business sweep account: Transfers excess cash from a business account to a higher-interest account, such as a money market or brokerage account.
• Loan or credit line sweep: Moves extra cash to pay down short-term debt or a line of credit.
• Payroll sweep account: Ensures sufficient funds in a payroll account for businesses.
• Investment sweep account: Transfers excess cash into compounding accounts like money market accounts, Treasury bills, or mutual funds.
• Insured cash sweep (ICS): Distributes extra cash across multiple FDIC-insured accounts for maximum protection.

How sweep accounts work

In a sweep account setup, you set minimum and maximum thresholds for your primary account. When your balance exceeds the maximum, the extra cash is automatically transferred to a designated secondary account, such as a high-yield savings account, money market account, or other investment account.

This automated process allows your excess cash to earn higher interest rates or potentially grow through investments rather than sitting in a low-interest checking account.

Natalie Bullen, a money coach for business owners and founder of Unapologetic Wealth, explains, “When you hold onto too much cash, your money is underutilized, and you're losing your purchasing power. Investing is one of the best ways to multiply your money — having a sweep account is smart because it's linked to your checking or savings. The money can be transferred without the owner having to act."

Benefits of using a sweep account

A sweep account can offer several advantages:

1. Higher interest earnings: Money market and high-yield savings accounts tend to offer better interest rates than traditional checking or savings accounts.
2. Improved liquidity management: Automated transfers reduce the need for manual account management.
3. Overdraft protection: Some sweep accounts can transfer funds from a line of credit to prevent overdrafts.
4. Potential tax benefits: Sweeping cash into certain investment accounts may offer tax advantages. For example, you could sweep cash into money market funds and investment accounts that grow tax-free.

One under-realized benefit is the psychological benefits of automated money management. Matthew observes, "A lot of times, when the money is just sitting there, there's an inclination to want to use it. When it's pulled away and set aside automatically, it gets into people's minds that it's not just sitting there for them to use — psychologically, it has an impact and leads to more saving and investing."

Potential drawbacks and considerations

While sweep accounts can be beneficial, they're not without potential downsides:

1. Fees: Some institutions charge for sweep account services, ranging from $20 to $150 per month or a percentage of the deposit.
2. Minimum balance requirements: These vary by institution and may impact the account's effectiveness.
3. Variable returns: Interest earnings and returns can fluctuate depending on where the cash is swept.
4. FDIC insurance implications: Spreading cash across multiple accounts may affect FDIC coverage.
5. Reduced accessibility: Some accounts that receive swept funds may have withdrawal restrictions.

Matthew cautions: "If your income fluctuates significantly and you need that main account to hold cash as a buffer, then you may not be ready for a sweep account. It's pulling money away from your main account, so it's not as easy if you don't have large cash reserves coming in, more than it’s going out.”

Who should consider a sweep account?

• Businesses with fluctuating cash flow: If your business experiences seasonal fluctuations or irregular income, you can use sweep accounts to maximize earnings during high-cash periods.
• Business owners with loans: You can use a sweep account to transfer extra cash to pay down a loan and potentially reduce interest costs over time.
• Investors: You can sweep your cash into investment accounts without active management.
• High net-worth individuals: Sweep accounts are also good for high-net-worth individuals and those with large cash balances. Large deposits can offer more substantial FDIC protection when spread across insured accounts.

Bullen shares insight from her experience: "When I used to work with clients as a financial advisor, I had clients with balances of $500,000 into the millions sitting in cash. Certain clients are risk-averse; they weren't investing the funds because they were worried about market volatility. It would make me fall out of my chair when I saw someone sitting with that much uninvested cash. A sweep account would be a better option.”

Alternatives to sweep accounts

If a sweep account doesn't sound right for you, consider these alternatives:

• High-yield savings accounts: These typically offer higher interest rates than traditional banks and can be a good option for those who want easy access to their funds.
• CDs: With higher interest rates, the yield on some of the top CDs can be as high as 5% APY. A CD requires you to keep your money in the account for a period, so they’re best for those who don’t need immediate access to the cash they put in.
• Money market mutual funds: These accounts allow investments in short-term securities, offering potentially higher yields with lower risk compared to other investment options.
• Bonds: A more conservative option for investing excess cash, bonds can provide steady income and are generally less volatile than stocks. You can invest extra cash into a Bond index fund, ETF, or individual bonds.

How to set up and manage a sweep account

To set up a sweep account:

1. Choose a primary account and a secondary account for transfers. Your primary account is typically your main checking account, while the secondary could be a money market account or investment account.
2. Set a minimum balance for your primary account. This will ensure that you always have enough funds for day-to-day expenses and unexpected costs.
3. Determine the maximum balance that triggers a sweep. Any funds above this amount will be automatically transferred to your secondary account.
4. Select a secondary account type that aligns with your financial goals. Consider factors such as interest rates, accessibility, and risk tolerance.
5. Monitor your ongoing cash needs and adjust thresholds as necessary. Your financial situation may change over time, so it's important to review and update your sweep account settings periodically.

Ask a professional for advice

While sweep accounts can be a powerful tool for cash management, it's always wise to consult with a financial professional before making significant changes to your financial strategy.

Jayson Thornton, a certified financial planner and founder of Thornton Financial, emphasizes the importance of seeking qualified advice: "Registered financial professionals have a fiduciary duty to their clients. The issue with just anyone giving you advice is they have no responsibility to follow these guidelines. My fiduciary duty means I'll put the welfare and interest of my client first. Personal finance advice and strategy should be tailored to your circumstances."

A financial advisor or other professional can help you determine if a sweep account is the best strategy for your situation, considering factors such as your income, expenses, financial goals, and risk tolerance.

Frequently asked questions

The bottom line

Sweep accounts offer an automated solution for managing excess cash, potentially protecting its value against inflation and maximizing your returns. By moving idle funds into higher-yielding accounts or investments, sweep accounts can help you make the most of your money without constant manual intervention.

Consider the pros and cons, including fees, minimum balance requirements, and your specific financial situation. With the right approach, you can make your cash work smarter, not harder.