The rules are trickier than you think. And the bailout package changed some—temporarily
On Oct. 3, 2008, President George W. Bush signed into law the much-heralded economic bailout legislation, the Emergency Economic Stabilization Act of 2008. Among its provisions, the act temporarily increases the basic insurance coverage limit provided by the Federal Deposit Insurance Corporation (FDIC) for depositors in banks and savings and loan associations from $100,000 to $250,000 per depositor through Dec. 31, 2009. After 2009, this amount returns to $100,000.
Here’s a summary of the new rules and an explanation of how to apply them. It may be trickier than you think—especially with revocable trusts.
But before we get into the nitty gritty, here are a few bottom lines: To minimize the risk of uninsured deposits for a joint revocable trust account, a good rule of thumb is to maintain an aggregate balance of no more than $500,000 for the trust and any individual joint accounts held at any one insured financial institution. For a one-grantor revocable trust, the aggregate balance for the trust and any individual single accounts should not exceed $250,000 at any one insured financial institution. When multiple trusts are concerned, the safest path, pending further guidance from the FDIC, is to limit the aggregate balance of all trust accounts at any one insured financial institution to $250,000 (or $500,000 if one or more of the trusts is a joint trust).
Depositors in all account categories should keep the balances in their deposit accounts low enough to leave some headroom for interest that may accumulate over time.
Let’s look at why we think these are the best approaches right now and where there are still some questions that the FDIC needs to answer.
What Does FDIC Insurance Cover?
Investors have a wide array of investment vehicles from which to choose, each with its own risks. An investor who deposits funds in certain accounts at certain financial institutions (such as banks, savings and loan associations or credit unions) is establishing a deposit account. Deposit accounts typically include checking accounts, savings accounts, negotiable order of withdrawal (NOW) accounts, money market deposit accounts, and time deposit accounts such as certificates of deposit (CDs). The terms of deposit accounts authorize the financial institution to use the deposited funds to make loans to other customers. Thus, deposit accounts are potentially at risk of default if the financial institution’s financial position becomes weak (for instance, due to poor loan portfolio performance). FDIC insurance was specifically designed to protect depositors from the risk of default that is unique to deposit accounts. This insurance is provided by “insured” banks and savings and loans. You can verify whether a particular financial institution is insured by using a service the FDIC provides online called “Bank Find,” or by calling toll-free 1-877-ASK-FDIC.
Note: this risk of default does not normally arise when an investor establishes an investment account to purchase and hold stocks, bonds, annuity contracts, mutual funds (including certain money market funds) or other investment products, even if the investment account is established at a bank or savings and loan institution, because the financial institution must hold each investor’s investments in the investor’s name and is not allowed to use the investments for loans or other investment activities.
Coverage Limit Ownership Categories.
Different coverage limit rules apply to several ownership categories. The coverage limit for any given ownership category is applied to the combined balance of all accounts in that category at any one financial institution. But if multiple accounts at the same financial institution fall into different ownership categories, the coverage limits are applied separately for each category, which may produce greater overall coverage.
There are seven common ownership categories: (1) single ownership accounts; (2) joint ownership accounts; (3) certain retirement accounts; (4) employee benefit plans; (5) accounts for corporations, partnerships or unincorporated associations; (6) accounts for “informal” and “formal” revocable trusts; and (7) accounts for certain irrevocable trusts. In addition, on Oct. 14, 2008, the FDIC created an umbrella, announcing that unlimited coverage will apply to (8) any account that is non-interest bearing, such as a checking account, regardless of ownership category.
Here’s a summary of the coverage limits for each of these categories:
(1) Single Accounts—are the first ownership category under the FDIC rules; these are accounts that have one individual owner and no beneficiary. Single accounts owned by the same depositor at the same insured financial institution are aggregated, and the total is insured up to the basic coverage limit, which is temporarily $250,000 per depositor.
(2) Joint Accounts——those that have two or more owners and no beneficiaries—are a separate ownership category under the FDIC rules. Each co-owner’s respective share of each joint account at the same insured financial institution is aggregated, and the total is insured up to the basic coverage limit, which is temporarily $250,000. Thus, with a joint account, a husband and wife can qualify for up to $500,000 of insured deposits at the same insured financial institution. (In community property states such as California, accounts titled in the name of one spouse will be classified as a single account of the named spouse for insurance purposes, even though under state law the funds may be considered to be owned one-half by each spouse.) Because single accounts and joint accounts are treated as different categories, co-owners who also own single accounts may qualify for greater coverage. Let’s see how this works:
Mary has a single ownership account with $250,000. Mary and John also own a joint account with $500,000. One-half of the joint account ($250,000) is deemed held by Mary and one-half of the joint account ($250,000) is deemed held by John. Thus, the entire $500,000 joint account is insured as a joint account, and the entire $250,000 single account is also fully insured. As a result, the total value of these accounts is insured for $750,000. If John also has a $250,000 single account, the total coverage reaches $1 million.
(3)Retirement Accounts—Certain self-directed retirement plans are treated as a separate ownership category under the FDIC rules. The FDIC rules provide a coverage limit unique to retirement plan and employee benefits accounts, rather than the basic coverage limit. By coincidence, this unique retirement plan coverage limit has been and continues to be $250,000. The amount was not changed by the bailout law and will continue to apply after 2009.
All of an individual’s deposits in certain self-directed retirement accounts (for example, traditional IRAs and Roth IRAs, Keogh plans, etc.) at the same insured financial institution are added together and insured up to $250,000.
(4) Employee Benefit Accounts—The FDIC rules treat as a separate ownership category accounts maintained by employee benefit plans for multiple employees. Coverage for each account held by an employee benefit plan covering multiple participants is determined by using a “pass-through” concept that calculates the portions of the account that correspond to the respective interests of each participant in the plan, and provides coverage for the amount of each interest up to the retirement coverage limit of $250,000 each.
(5) Corporations, Partnerships, and Unincorporated Associations—Accounts for corporations, partnerships, limited liability companies (LLCs), and similar entities (including those operating as non-profit organizations) are recognized as another ownership category. Accounts for such an entity at one financial institution are subject to the basic coverage limit (temporarily $250,000), regardless of how many shareholders, partners, members, etc. may exist. In addition, non-interest bearing accounts held by any owner qualify for temporary unlimited coverage.
(6) Revocable Trust Accounts—The FDIC rules recognize certain accounts as revocable trust accounts and treat them as a separate ownership category. There are two types of accounts insured under this ownership category: the “informal” and “formal.” Informal trust accounts consist of a bank signature card on which the owner designates the names of beneficiaries to whom the funds will pass upon the owner’s death. These are usually referred to as “payable-on-death” (POD), “in-trust-for” (ITF), or “Totten Trust” accounts. Formal trust accounts are established in connection with written trust documents such as those created for estate-planning purposes. In either case, the individual owner has retained the right to revoke the arrangement.
Coverage that applies to accounts for informal and formal revocable trusts is based only on the number of beneficiaries and does not include the owners (who, in the eyes of the FDIC, could establish single or joint accounts to obtain their own coverage under another category). Also, each beneficiary’s interests in each and every revocable trust account held at a financial institution by the same owner are generally subject to one basic coverage limit (temporarily $250,000).
(a) Informal Trust Accounts—Deposit insurance coverage for an informal trust account is determined by multiplying the number of beneficiaries named on the account by $250,000. Note that the beneficiaries must be specifically named in the deposit account records of the insured financial institution.
For example: Jill has an account that is POD to her two children. The account has a balance of $500,000. Assuming Jill has no other revocable trust accounts naming the same beneficiaries, the available insurance coverage is $500,000, because there are two beneficiaries (Jane’s children) named on the account.
Let’s look at another example with the same facts, but say that Jill also has a single ownership account with $275,000. Jill is entitled to $250,000 of insurance coverage on the single account, in addition to $500,000 coverage on her POD account. Only the excess $25,000 held in the single account is not insured.
(b) Formal Trust Accounts—The rules for formal trust accounts have generated confusion over the years. As a result, the FDIC Board of Governors adopted an interim regulation on Sept. 26, 2008, to try and simplify the coverage rules on these accounts. This regulation was revised on Oct. 8, 2008, and more revisions may be needed to resolve remaining questions.
Coverage for formal trusts is provided on a “per beneficiary” basis. The prior rules limited coverage to beneficiaries consisting of the account owner’s spouse, children, grandchildren, parents and siblings. The new, interim rules delete this requirement and extend coverage to any individual or non-profit organization. But note that the FDIC definition of a “beneficiary” is limited, and may still exclude some individuals or charities named in many common types of trusts. More on that later.
The interim regulation describes two different coverage rules. The description in the regulation does not match the discussion provided by the FDIC on its web site, but we think that we’ve captured the concepts intended by the FDIC in this summary:
• Five or fewer beneficiaries—For each trust with five or fewer “beneficiaries” (as defined for FDIC purposes), the maximum coverage at any given financial institution is determined by multiplying the number of different “beneficiaries” (as defined for FDIC purposes) by the basic coverage limit (temporarily $250,000).
So, for example, say that Ann has a living trust account with a balance of $1 million. Ann’s trust provides that upon her death, the trust assets will be distributed outright and free of trust in equal shares to Ann’s three children. Because the children will receive outright distributions at Ann’s death, each qualifies as a beneficiary for FDIC purposes, and the maximum insurance coverage is $750,000 (three times $250,000).
Let’s look at Ann’s situation if she also has a single account worth $300,000. Ann’s single account is insured separately (up to a maximum of $250,000), in addition to the $750,000 coverage in her living trust account, producing total coverage of $1 million. (After Dec. 31, 2009, the single account would be insured up to a $100,000 limit, and the trust account would have coverage up to $100,000 per beneficiary, producing total coverage of $400,000.)
• Six or more beneficiaries—For revocable trust accounts with six or more different beneficiaries, the maximum coverage is the greater of (1) $1.25 million; or (2) the aggregate amount of all the beneficiaries’ “beneficial interests” in the trust, limited to the basic coverage limit (temporarily $250,000) per beneficiary. For purposes of these rules, the term “beneficial interest” refers to the portion of the account that the beneficiary would receive outright upon the grantor’s death (or, in the case of a joint revocable trust, upon the surviving grantor’s death), subject to the requirement that the interest does not depend on the death of another trust beneficiary. Any interest that is not distributed outright is not recognized as a beneficial interest, except for a “life estate” or “income for life” interest, which is automatically assumed to be worth the basic coverage limit (temporarily $250,000). This is a significant limitation in the FDIC coverage rules, as many trusts provide for interests that do not fall into these limited categories (for example, it is common for a beneficiary’s interest to continue in trust after the grantor’s death).
So say that Jim has a living trust account with a balance of $1.5 million. Jim’s trust provides that upon Jim’s death: (a) his three children are each entitled to $200,000 (outright and free of trust); (b) Jim’s friend is entitled to $10,000; (c) a designated charity is entitled to $100,000; and (d) the remainder of the trust assets is to be distributed outright to Jim’s wife, Susan. In this case, the balance of the account is over $1.25 million and there are more than five beneficiaries. Thus, the maximum coverage available for this account is the greater of $1.25 million, or the aggregate of each different beneficiary’s interest, limited to $250,000 per beneficiary. The beneficial interests in the trust for purposes of determining coverage are: $200,000 for each of the children (totaling $600,000); $10,000 for the friend; $100,000 for the charity; and $790,000 for Susan (limited to $250,000); or $960,000 in all. Thus, the FDIC coverage on the account is $1.25 million (the greater of $1.25 million or $960,000).
Let’s say we have the same fact pattern but that Jim has five children instead of three, who are each entitled to $200,000. Again, because the balance of the account is over $1.25 million and there are more than five different beneficiaries named in the trust, the maximum coverage available on the account is the greater of $1.25 million, or the aggregate of each different beneficiary’s interest, limited to $250,000 per beneficiary. Now, the beneficial interests in the trust for purposes of determining coverage are: $200,000 for each of the children (totaling $1 million); $10,000 for the friend; $100,000 for the charity; and $250,000 for Susan ($390,000, subject to the $250,000 limit per beneficiary); or $1.36 million in all. Thus, the FDIC coverage on the account is $1.36 million (the greater of $1.25 million or $1.36 million).
• No beneficiaries—If an account is held by a revocable trust that does not have anyone who qualifies as a beneficiary, the account is viewed as falling into the ownership category associated with a single account (for a one-grantor trust) or a joint account (for a two-grantor trust), and would be aggregated with any other single or joint accounts, as the case may be.
• Joint revocable trust—It is common in community property states for two grantors to form a revocable trust. With a joint revocable trust account, each owner’s interest is analyzed separately, subject to the same limits described above. In other words, when a husband and wife establish a joint revocable trust, they are each deemed to be a separate grantor of the trust for purposes of determining insurance coverage.
For example, Sam and Linda create a joint revocable trust with an account balance of $4 million. They have no children of their marriage, but Sam has four children from a prior marriage, and Linda has two children from a prior marriage. Sam and Linda want to treat all six children equally, and under the terms of the trust, upon the surviving spouse’s death, the trust assets will be divided into six equal shares and distributed outright to the six children. Sam and Linda each own equal interests in the trust. Under the FDIC rules, each of Sam’s and Linda’s interests is analyzed separately. The coverage for each of Sam’s and Linda’s interests is the greater of $1.25 million or the aggregate amount of the beneficial interest of each beneficiary (limited to $250,000 per beneficiary). Sam’s and Linda’s interests represent $2 million each, and the six children’s respective interests in each is $333,333. But coverage cannot exceed $250,000 per beneficiary, so the beneficial interests of the beneficiaries is considered to be $1.5 million (six times $250,000). This amount exceeds $1.25 million, so each of Sam’s and Linda’s interests is covered for $1.5 million and the account qualifies for aggregate coverage of $3 million ($1.5 million each for Sam and for Linda). If Sam and Linda also own a “joint account” as individuals of $500,000, their combined coverage is $3.5 million.
Note: if Sam’s and Linda’s joint revocable trust provides that the six children’s interests continue in trust after the deaths of Sam and Linda, the children no longer qualify as beneficiaries under the FDIC rules. Then, the joint revocable trust has no beneficiaries and is instead treated as a joint account owned by Sam and Linda individually.
Let’s look at another example. Say the facts are the same, but 75 percent of the trust property belongs to Sam, which means that Sam’s interest in the joint revocable trust account is $3 million and Linda’s interest in the account is $1 million. The maximum coverage for Sam’s interest will still be $1.5 million (the greater of $1.25 million or the aggregate amount of beneficial interests), but the coverage for Linda’s interest in the trust account cannot exceed her ownership interest, which in this case means that her coverage is limited to her $1 million. Thus, the total maximum coverage for the account would be $2.5 million.
As mentioned earlier, we see a problem with the FDIC’s definition of “beneficiary.” The FDIC concept works well enough for informal trust accounts, since these accounts generally provide outright distributions to named beneficiaries who are listed in the account records of the financial institution.
However, the FDIC applies similar rules to formal revocable trusts and to irrevocable trusts, and limits the concept of “beneficiary” to those who receive interests outright, or who receive certain “life estate” or “income for life” interests. Although these rules may be workable for estate plans that provide only outright distributions, the rules will not work well for estate plans that provide more advanced forms of inheritances, such as continuing trusts, because the trust beneficiaries may not be recognized as “beneficiaries” for FDIC purposes. These advanced forms of inheritances are usually an integral part of the estate plan because they can provide significant tax and non-tax advantages. As a consequence, trusts will qualify for substantially different levels of coverage depending on whether beneficiaries receive their interests on an outright basis. Problems may also arise if trustees allow deposits to exceed the actual coverage available due to confusion over this definition of “beneficiary.”
(7) Irrevocable Trusts—The FDIC rules also create a separate ownership category for irrevocable trusts. Some trusts are irrevocable because they were designed that way from the start (often for tax planning or creditor protection purposes). Other trusts start out as revocable trusts and become irrevocable upon the occurrence of a specific event (often the death of a grantor).
The FDIC rules specifically provide that any irrevocable trust created due to the death of a grantor of a revocable trust will continue to be insured under the “revocable trust” ownership category, rather than the “irrevocable trust” category. The FDIC rules do not provide guidance as to whether multiple coverage limits will apply if multiple irrevocable trusts with the same or similar beneficiaries arise at a grantor’s death (for example, marital and credit shelter trusts may arise at the death of the first spouse to die). Hopefully, further guidance will be forthcoming.
Other irrevocable trusts (that is to say, those not created due to the death of a grantor) are entitled to FDIC insurance coverage in an amount equal to the greater of (a) $250,000 for the entire trust; or (b) the values of the “beneficial interests” of the “beneficiaries” (using the same definitions described above for formal revocable trusts), up to the basic coverage limit (temporarily $250,000) per beneficiary. As a practical matter, most irrevocable trusts will probably be limited to $250,000 of coverage, since most irrevocable trusts contain conditions that cause each beneficiary of the trust to fail to satisfy the FDIC definition of “beneficiary.”
(8) New Rule Protects Non-Interest Bearing Accounts—The FDIC coverage rules are subject to change, as illustrated by the Oct. 14, 2008 announcement that an unlimited coverage limit applies, temporarily, to any account that is non-interest bearing, such as a checking account, regardless of the ownership category. This announcement is particularly welcome news to business accounts that are likely to have higher working balances to cover payroll expenses and the like. But this unlimited coverage is temporary, and expires after Dec. 31, 2009. Unfortunately, the FDIC announcement does not provide guidance as to how the unlimited coverage interacts with the basic limit that might otherwise apply.
For example, Terry owns a savings account with a $300,000 balance and a non-interest bearing checking account with a $600,000 balance. The $600,000 balance in the checking account is clearly covered, but it’s unclear what portion, if any, of the savings account is covered, because the coverage on the checking account might be deemed to come first from the $250,000 basic limit that applies to single accounts and then from the unlimited coverage. Hopefully, more guidance from the FDIC is forthcoming.
Note that the National Credit Union Association (NCUA) provides similar insurance coverage for depositors in credit unions, and the act temporarily increases the basic coverage limit provided by the NCUA in the same manner as that of the FDIC. The NCUA coverage rules are similar, but not necessarily identical, to those of the FDIC. For more information about the NCUA rules, visit the NCUA’s web site, www.ncua.gov.