Uncertainty makes investors nervous. And we’ve got uncertainty now; we’ve had it before and we’ll have it again.
Part of having experienced uncertainty in the past is that there are institutions set up for investor protection, safeguarding against the risk of default by some financial institutions. A primary objective of the protections provided by the organizations is to quell some investor fears. They do this by insuring or otherwise protecting assets held by member institutions against the default of the institution. The coverages are very specific and the details matter.
Banks and credit unions can fall under the umbrella of the Federal Deposit Insurance Corporation (FDIC) and National Credit Union Administration (NCUA) respectively. Both are agencies of the U.S. government. Brokerages fall under the umbrella of the Securities Investor Protection Corporation (SIPC), a nonprofit corporation mandated under the 1970 Securities Investor Protection Act. Let’s take at look at what each of these entities does for investors.
Federal Deposit Insurance Corporation
The FDIC is the granddaddy of these institutions, having its roots in the Great Depression when the federal government formed the FDIC to help depositors have confidence in their banks.
Most banks participate in FDIC insurance. You can find out if a bank is a member of FDIC by asking, by a notice that is usually prominently displayed, or by looking it up on the FDIC website. The purpose of the insurance is first and foremost the confidence of the depositors, hence the banks typically aren’t shy about posting their membership.
The FDIC insures deposit accounts against bank failure. There are a couple of significant points in that little statement.
Not all money you might have in a bank is covered — deposit accounts are covered. Deposit accounts are traditional banking accounts, checking, savings, money market deposit accounts, and CDs. This leaves any investment accounts not covered by FDIC insurance. Note also that the FDIC-covered money market accounts are deposit accounts issued by a bank, not money market mutual funds, which are issued by fund companies.
Coverage is provided up to $250,000 per depositor per account ownership type. This means you could have more than $250,000 in total coverage, potentially a lot more.
Coverage is provided for your checking and savings accounts, your interest in a joint account, your IRA, money market deposit account, and your CDs. You could also have irrevocable or revocable trust ownership. There’s the potential to have a few different types of accounts each covered for $250,000. For a joint account, your interest would be covered for the full $250,000, as would be the other party’s interest.
Be careful to note that it is $250,000 per bank per depositor per account ownership type. You can multiply your coverage by using multiple banks. Your coverage in any one bank is limited by those delimiters; your individual accounts such as checking and savings and money market deposit accounts are all yours and all with the same ownership and covered for $250,000 in total, not each.
Some of those account types can hold investments other than deposits. Take an IRA, for example: It might hold cash in a savings account or a CD, or it might be invested in a mutual fund. Only cash in a deposit account is covered by FDIC insurance; if you have other types of investments in an IRA or other account, even though you got it through the bank, it is not FDIC insured.
FDIC insurance comes into play when a bank is in serious financial trouble — typically this means the bank is in default and going bankrupt.
Default is the trigger where the FDIC steps in. In most cases the action is quick, with investors getting their account value, including interest through the date of default, at another member institution within a day or two. Some accounts (irrevocable trusts for example) can take longer as the documentation needs to be reviewed in order to make the correct restitution.
Just because the FDIC insurance limit is $250,000 that doesn’t mean that $250,000 is all you can get back in the event of a bank default. If you have considerably more on deposit in an account at the bank, you may end up getting most or all back — eventually.
It could take a lot of time for the assets of the bank to be liquidated and you to receive some portion of your funds over the insurance amount. The issues are that you are not guaranteed anything over the $250,000 per depositor per account ownership limit, and it could be months or even years.
National Credit Union Administration
The NCUA provides insurance for member credit unions; NCUA coverage is similar to FDIC.
You would determine if your institution is a member in the same fashion. There is most likely prominent signage. You can also ask or check online; it should be pretty straightforward.
Like FDIC insurance, coverage is for deposit accounts, typically referred to as share accounts in credit union lingo. Again, investment accounts are not covered.
The limits are the same at $250,000 per institution per account ownership type. You can multiply your coverage by using several different member institutions and leveraging ownership types.
Securities Investor Protection Corporation
This one’s different.
SIPC coverage is not the same as FDIC or NCUA coverage. The intent is similar, to assuage the fears of the public. The SIPC is a nonprofit corporation, not an agency of the government; it’s authority is far more limited.
The SIPC provides coverage for brokerage products and cash held in brokerage accounts. There is a limit of $500,000 per person per account ownership type, with a limit of $250,000 of that for cash held for investing.
The SIPC states their purpose is to “recover missing cash or securities if your brokerage firm has gone out of business.”
The SIPC steps in to the liquidation of a member brokerage if there are missing assets, either cash or securities. The process is similar to bankruptcy proceedings.
While the SIPC is providing coverage for investments, it is for most investments and against their having been taken — they are missing or were misused by the brokerage firm. The SIPC does not provide coverage against investment losses or against bad advice or poor decisions. The protection is limited to situations in which the brokerage needs to be liquidated and there are assets missing or potentially missing.
A key here is that the coverage is going to be applied to those missing assets.
For example, you have $5,000,000 held in a brokerage account in qualifying assets. The brokerage firm goes under and $4,600,000 of your assets are immediately recovered. The remainder is covered under SIPC — your missing assets are less than the coverage limit, assuming you don’t exceed the cash limit of $250,000.
There are some further limits to the SIPC’s coverage. They do not provide coverage for futures, precious metals, investment contracts such as limited partnerships, nor some fixed annuities; they also do not provide coverage for cash used in association with commodities trading.
When considering account ownership types, there are some different rules in play. For joint accounts, the $500,000/$250,000 limits apply to the account, not to each of the joint owners as is the case for FDIC and NCUA coverages. Under any of the coverages, multiple traditional IRAs with the same ownership are amalgamated for the purpose of coverage limits.
How It All Fits Together
The purpose of the institutions is investor confidence. That is an end they serve well.
Certainly, if you are looking for a bank or credit union to do business with, there is no downside to seeking one that is member of the FDIC or NCUA. Most are; it would probably be more difficult to find one that’s not.
Brokerages are required to be members of the SIPC. You should still check in the same manner as you would for FDIC or NCUA membership.
In all cases, the primary role is to protect your assets in the extreme case of the insolvency of your financial institution. All the organizations have been involved in many proceedings; they are there to do what they do and they do it. The need for the insurance aspect comes into play in only a portion of the cases; it is normal for all or nearly all of the consumers’ assets to be readily recoverable.
But there are other cases where that isn’t so. Those are the real reason we need the institutions. Although the total they actually have to pay out on is only a small percentage of cases, the cost to individual investors of not having the protection would be excessive.
You can always multiply your protection by using multiple banks, credit unions, or brokerages. This is more of a conceptual solution than a practical one. For banks and credit unions, it is rare that an individual should carry over $250,000 in cash in one ownership type, or even in combined ownership types. Do something more productive with the money instead.
Many brokerages carry insurance in excess of SIPC, and that is worth inquiring about. But even if they do not, it needn’t be a deal breaker.
You would probably be better served by paying attention to any mentions of your brokerage in news coverage and paying close attention to your statements and transaction records. Any inappropriate transactions showing up on your account statements or transaction records are red flags. That’s when you need to be looking elsewhere, at the first sign of trouble. The protection is there for after the fact.
The FDIC, NCUA, and SIPC are fantastic institutions that have helped in the protection of many investors and the confidence of legions more. There roles are, however, limited. If you know how they work, you can see if you need do anything differently.