With the recent failures of Silicon Valley Bank (here’s my blog on the SVB Closure Explained), Signature Bank, and most recently, First Republic Bank, consumers have been left to wonder about their own funds and the inherent safety nets built in to protect their assets. The Federal Deposit Insurance Corporation (FDIC), Securities Investor Protection Corporation (SIPC), and State Guaranty Associations (SGA) each play a critical role in protecting consumers’ assets in the event of a financial institution’s failure or insolvency. While they each have their own lane (FDIC is for bank accounts, SIPC is for investment accounts, and SGA for insurance products), they each have a common aim of insuring consumers money in the event of institutional failure. Understanding these organizations and their coverage limits can help you make informed decisions on where to place your assets and how to protect them.
FDIC
The OG of consumer protection agencies, the FDIC, was created in 1933 as a response to the instability of financial institutions during the Great Depression. Ultimately the goal of the FDIC is to give consumers enough confidence in banking institutions to avoid any runs on the bank that deplete the bank’s available capital and can lead to the bank failing altogether. The FDIC insures up to $250,000 per bank, per depositor, and per ownership category. Let’s take a little deeper look at what this actually means:
• Per Bank: This one is relatively self-explanatory; this simply refers to where your deposits are held.
• Per Depositor: This can reasonably be explained as the individual holding the account.
• Per Ownership Category: This is where it gets a little murkier. The FDIC names 8 separate ownership categories. I won’t name them all for brevity’s sake, but the three that will be most impactful for the average person are Single Accounts, Joint Accounts, and Trust Accounts.
To illustrate, let’s look at a case study of Scrooge McDuck. Since our last interactions with Scrooge, he has now married a wonderful duck named Sally, and she has convinced him that instead of putting all their money in a gold pit to swim in, they should at least seek out some security at a local bank. As ever the conservative and shrewd businessman, Scrooge is seeking to maximize his FDIC insurance. For this reason, Scrooge opens individual accounts for him and Sally as well as a joint account (with both him and Sally listed on the account) and for good measure also opens a trust account tied to a revocable trust he had made up before he and Sally wed. This has effectively given Scrooge and Sally $1 Million in FDIC insurance protection: $250k for Scrooge’s account, $250k for Sally’s account, $250k for the joint account, and $250k for the trust account. While this isn’t a complete maximization of his FDIC insurance (he could either go to more banks or create more account types), this serves as an illustration of how you can stack different ownership categories to increase the amount of funds insured.
Securities Investor Protection Corporation (SIPC)
The SIPC was later created as a result of failures of broker-dealers in the late 1960s. While the FDIC is designed to protect your banking assets, the SIPC is designed to protect your securities. This is the world that we live in here at QED Wealth Solutions. While the general mechanics are still the same, protecting consumers in the event of a financial institution’s failure, it is important to understand some key differences:
• Separate Capacities – While FDIC is covered Per Bank, Per Depositor, Per Ownership Category, the SIPC covers Per Broker-Dealer, Per Investor, Per Separate Capacities. While the first two stipulations are virtually the same, the separate capacities language is a more liberal definition of what is covered as it refers to different account types: an IRA, Roth IRA, and Taxable brokerage account all held by one individual are considered separate capacities and would each have separate coverage under the SIPC rules.
• Limits – SIPC protects up to $500,000 per investor, per account type, which includes a maximum of $250,000 of cash coverage
• Additional Insurance coverage – While it is rare for banks to insure more than the FDIC amount, most broker-dealers purchase additional insurance to protect consumers from this risk. Altruist, who acts as the broker-dealer for QED Wealth Solutions has an additional $40 Million per account of coverage.
Sticking with Scrooge and Sally McDuck, Sally convinces Scrooge to invest a piece of their nest egg with QED Wealth Solutions (what a sensible duck Sally is 😊). Ignoring contribution limits for illustrative purposes, they put $2 Million in an IRA for Scrooge and the same for Sally, $2 Million each into two separate taxable accounts both with Scrooge as the owner, and $2 Million in a joint taxable account. They would have $500,000 of SIPC coverage for each of their IRAs, $500,000 of SIPC coverage across both of Scrooge’s two taxable accounts, and $500,000 for their joint taxable account. They would also have $1.5 Million of additional coverage for each of their IRAs, $3.5 Million of excess coverage for Scrooge’s two taxable accounts and $1.5 Million of additional coverage for their joint taxable account provided by the additional insurance coverage utilized by our custodian. While I can’t speak to what, if any, additional coverage other broker-dealers may have in excess of the SIPC limits, as stated above the broker-dealer utilized by QED Wealth Solutions carries coverage for an additional $40 Million per account.
State Guaranty Association
State Guaranty Associations were also established in the 1930s, during the Great Depression, as a response to the large number of insurance company failures that left policyholders without coverage. These state level associations guarantee insurance products issued in their state including life insurance, health insurance, and annuities. The biggest differences between FDIC, SIPC, and SGAs is due to how they are regulated. Insurance is regulated on the state level and thus the SGAs are administered at the state level. Ultimately their goal is the same as SIPC and FDIC, to protect the consumer in the event of an institutional failure. In the state of Kansas, the SGA protects up to $250,000 of the value of an annuity, up to $300,000 for the death benefit of a life insurance policy, and up to $100,000 of cash value in a life insurance policy. These values are aggregated for the type of policy. The state of Kansas defines three policy types: Life Insurance, Health Insurance, and Annuities.
Back to Scrooge and Sally, in addition to the planning that they have done at their local bank and the investments they have made with QED Wealth Solutions, they have decided that life insurance is necessary to help offset some of the tax expenses in the event of Scrooge’s death. Scrooge decides that he needs two $1 Million life insurance policies: one for Sally and one for Donald, his favorite nephew. Additionally, he decides to place $1 Million in an annuity. Because Scrooge knew about the State Guaranty Association coverage, he decided to take out his life insurance policies with two different insurance companies. Because of this, Scrooge has insurance coverage of $300,000 for the death benefit on each of his policies ($600,000 total) and coverage of $250,000 for his annuity. However, had Scrooge taken out both of his insurance policies with the same carrier, he would have only had $300,000 of total coverage in the event that the company failed.
Impact on Financial Decisions
So, what does all this mean, and should I let it impact my financial decisions? I certainly think that if you are significantly above the insurance limit at a banking institution it is worth shopping around and spreading out your money to different ownership categories and/or different institutions. There has simply been too much uncertainty in this sector, and ultimately if you are just looking for a parking place for your cash there is not enough of a difference in interest rates from institution to institution to keep you from diversifying out of this risk. It is a little tougher decision when it comes to your investment accounts and insurance products, as the product and service offering is much broader (meaning that what you receive at one place is not the same as what you are receiving at the next place) and simply put, their business models have not been as exposed to the interest rate risk that has led to the troubles experienced by some of these banks.
As always, if you would like help navigating the risks inherent in your financial life, schedule a meeting or a call.
This post is for educational and entertainment purposes only. Nothing should be construed as investment, tax, or legal advice.
