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With financial markets currently experiencing so much turmoil, for this month's Wealth IQ Report, we discuss the current rash of bank closures and how deposit insurance works for banks, credit unions, and brokerage accounts.
Please feel free to contact me at (888) 944-7736 if you have any questions about this article and how it may pertain to your situation.
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Darren Whissen
How Deposit Insurance Works
First, the good news: the nation's banks are currently in far less danger than they were in the late 1980s and early 1990s, when more than 1,000 federally insured institutions went under during the savings-and-loan crisis.
However, 12 banks have already failed in 2008. And, as home prices continue to decline and loan defaults mount, federal regulators are bracing for many more banks to fail. Just how many? A recent article in the New York Times estimated that as many as 150 out of the 7,500 banks nationwide could fail over the next 12 to 18 months.
With so many banks at risk, many people are reviewing the legal protections available for assets held by banks, credit unions, and securities dealers. Here are some of the protections available.
Bank Deposit Accounts
Generally, deposit accounts at banks insured by the Federal Deposit Insurance Corporation (FDIC) are insured up to $250,000 per depositor per bank*. FDIC insurance covers checking and savings accounts; money market deposit accounts; and time deposits, such as certificates of deposit (CDs). It does not cover money market mutual funds, stocks, bonds, mutual funds, life insurance policies, annuities, or other securities, even if they were bought through an FDIC-insured bank.
You cannot increase your protection simply by opening more than one account in your name at the same bank (for example, splitting the money between a checking and a savings account, or opening accounts at different branches of the same bank). However, deposits that represent different categories of ownership may be independently insured. For example, a joint account qualifies for up to $250,000 of coverage for each person named as a joint owner of the account. That coverage is in addition to the $250,000 maximum coverage for individual accounts for each person. For example, a married couple with three accounts at one bank--they each have $250,000 in an individual account, and they also have $500,000 in a joint account--would qualify for FDIC coverage of the entire $1,000,000.
The limit on the amount protected in one or more retirement accounts is $250,000; this is separate from the $100,000 coverage of individual accounts. (Remember, however, that FDIC insurance applies only to deposit accounts, not to any securities held in an IRA or other retirement account.)
Your bank may have additional protection. For example, in some states, a state-chartered savings bank must carry additional insurance to cover potential losses beyond the FDIC limits. Some banks also may participate in the Certificate of Deposit Account Registry Service (CDARS), which enables a bank to spread large CD deposits among multiple banks while keeping the amount at each individual bank, including itself, within FDIC insurance limits.
Click Here to visits FDIC's online calculator to help you estimate the total FDIC coverage on your deposit accounts.
Credit Unions
Member share accounts at most credit unions are insured by the National Credit Union Share Insurance Fund (NCUSIF). It is administered by the National Credit Union Administration (NCUA), which is an independent agency of the federal government and is backed by the full faith and credit of the U.S. Treasury. (Some credit unions are not federally insured but are overseen by state regulators; they typically have private credit insurance.)
NCUSIF insurance is similar to FDIC insurance. It covers single-owner accounts up to $100,000 per customer per institution. Retirement accounts such as IRAs and Keoghs have separate coverage up to $250,000. As with bank deposit accounts, independent coverage may be available for different categories of ownership.
Click Here to visit NCUA's online calculator to help you estimate your existing coverage.
Brokerage Accounts and SIPC
Most brokerage accounts are protected by the Securities Investor Protection Corp (SIPC). Unlike the FDIC, the SIPC is not a governmental agency but a nonprofit corporation funded by its membership, which is comprised of broker-dealers registered with the Securities and Exchange Commission. (Any broker-dealer that is not an SIPC member must disclose that fact to customers.)
SIPC was created by Congress in 1970 to help return customer property, including both securities and cash in brokerage accounts, if a broker-dealer or clearing firm experiences insolvency, unauthorized trading or securities that are lost or missing from a customer's securities account. Many brokerages also carry additional private insurance to extend coverage beyond the SIPC limits. Should a SIPC member firm become insolvent, SIPC would request a court to appoint a trustee to supervise transfer of customer securities and cash.
For individual accounts, SIPC covers a maximum of $500,000 per customer (including up to $100,000 in cash) at a given brokerage house or clearing firm. As with banks, total coverage can be higher for multiple accounts at one institution, depending on how they're held. For example, a married couple could have two individual accounts with $500,000 of coverage each, plus a joint account that would bring their aggregated coverage for that firm to $1.5 million. Each of your retirement accounts at a given firm also is generally eligible for an additional $500,000 of SIPC coverage (including up to $100,000 in cash) in the event securities in your account are lost or stolen.
It's important to remember that SIPC does not protect against market risk or price fluctuations. The value of securities at a failed institution is determined as of the date upon which a trustee is appointed. If shares drop in value before a trustee is appointed, that loss of value is not covered by SIPC. In general, SIPC covers notes, stocks, bonds, mutual funds and other shares in investment companies. It does not cover investments that are not registered with the SEC, such as certain investment contracts, limited partnerships, fixed annuity contracts, currency, gold, silver, commodity futures contracts or commodities options.
Click Here to view SIPC's status of any liquidation proceeding and if necessary, get a claim form.
Click Here for a current list of failed banks.
Conclusion
So, with more banks expected to fail, what should investors do? First, make a list of all of your bank accounts. Make sure each of your accounts is within the insured limits as outlined above. If any account has more money in it than what is insured, either open additional accounts at your current bank or credit union (if possible), or identify additional banks with which to open accounts.
Even if you're accounts are fully insured, it wouldn't hurt to open a second or third account at a different bank than what you're currently using. Think of diversifying your deposits much like you would diversify your investments. That way, if any one bank failed, you'll still have liquidity while you wait for FDIC to cut you a check.
Want more? Click Here to read my June article on Seven Smart Steps in a Volatile Market.
* Law in effect until December 31, 2009
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Disclosures
A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. The value of an investment in debt securities will change as interest rates fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. Investments in high-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income.
The opinions in the preceding commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole.
This material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict performance of any investment. Investing involves risk, including possible loss of principal. Investors should consult with a financial advisor prior to making an investment decision.
Diversification does not guarantee a profit or protect against loss in a declining market.
Click Here to read additional disclosures.