Special Report on FDIC Insurance

FDIC Consumer News - Fall 2001

Special Report on FDIC Insurance

Lessons from Losses: What You Can Learn from Recent Bank Failures

When a bank fails, practically all depositors are fully insured by the FDIC, either because they had less than $100,000 on deposit or their funds over $100,000 qualified for additional insurance protection. But as some customers have learned in recent bank failures, there are situations in which large-dollar depositors have not been fully protected. In fact, in the last 15 bank failures dating back to 1999, there were uninsured deposits totaling $114 million, some of which will be recovered by the depositors. How do people get into these predicaments? And what can you learn from their experiences?

In the last 15 bank failures, there were uninsured deposits totaling $114 million.

The FDIC knows that many uninsured depositors at recent bank failures were well aware that they had funds over the $100,000 federal limit and they were willing to take the chance that their bank wouldn't fail. They may have been attracted to unusually high deposit interest rates, or maybe they just liked the service or convenience offered by a particular bank and were willing to do all their business there, even if it meant that some money would be uninsured.

But we also know that there were other depositors who didn't think they were taking a risk—they believed all of their funds were fully insured—until they received the unpleasant news that their bank had failed and some of their money was uninsured. These are the kinds of situations that the FDIC wants to help avoid.

FDIC Consumer News asked FDIC attorneys, claims agents and other officials for examples of the most common mistakes and misconceptions that led to uninsured deposits at recent bank failures, and the lessons that all depositors should remember. Here's what we found:

Problems and Solutions

PAYABLE-ON-DEATH (POD) AND OTHER REVOCABLE TRUST ACCOUNTS. The insurance rules governing these types of deposit accounts where funds pass to specific beneficiaries when the owner dies (sometimes also called testamentary, Totten trust or In-Trust-For accounts) can provide for expanded insurance coverage, but the rules also can be complicated. Each beneficiary's share of a POD account can be insured up to $100,000 ($200,000 if there are two beneficiaries, $300,000 if there are three, and so on) but the beneficiary must be a "qualifying" beneficiary. That is, the beneficiary must be the grantor/depositor's spouse, child, grandchild, parent or sibling. Other relatives, such as nieces, nephews, cousins or in-laws, as well as friends, do not qualify the account for the additional insurance coverage provided to other POD accounts. What happens if you name a non-qualifying beneficiary? The portion payable to that person would be added to any accounts you have at the bank in the single (or individual) account category and the total will be insured to $100,000.

Martin Becker, a senior specialist in Washington with the FDIC division that handles insurance claims, adds that if you have a POD account with more than one depositor, "it's extremely important to pay attention to the relationship between each grantor and each beneficiary." Becker gives the example of Joe and his wife Mary who have just one deposit at a bank—a $400,000 POD account naming Joe's parents as the beneficiaries. Joe's share is insured to $200,000 ($100,000 for each beneficiary) because parents are qualifying beneficiaries. But Mary's share is insured to only $100,000. Why? Because his parents are her in-laws, and in-laws are not qualifying beneficiaries. Mary does not qualify for POD coverage in this case. Of her $200,000 share of the account, $100,000 would be insured as her individually owned funds at that bank, leaving $100,000 uninsured.

Among other common mistakes: "Many single people or those with no children are especially likely to name nieces and nephews as their account beneficiaries, and they don't qualify under the rules," says Kathleen Halpin, a Dallas-based FDIC insurance claims agent. Also, some POD account depositors incorrectly assume they receive $100,000 of coverage for each beneficiary and another $100,000 for themselves, as the account owner.

Real-World Example: One woman had more than $500,000 in POD accounts naming her nieces and nephews as beneficiaries. Because they were not qualifying beneficiaries, when the bank failed, this depositor was only insured to $100,000, leaving the rest uninsured.

The Lessons: If you've got POD deposits over $100,000, be aware of whom you've listed as beneficiaries and the relationships between each depositor and each beneficiary. Then, review FDIC publications such as "Your Insured Deposit" or ask FDIC staff to determine how those beneficiaries affect your insurance coverage. Make adjustments if necessary.

DEPOSITS THAT ARE PART OF A LIVING TRUST. For tax and inheritance reasons, many people set up a living trust as a way to retain full control over their assets before passing them to
beneficiaries. Although, technically, the FDIC's rules say a living trust account is a form of payable-on-death account, living trust deposits rarely qualify for the insurance coverage for POD accounts we described in the previous section. That's because the rules require that POD funds pass directly to the named beneficiaries without condition—and most living trusts documents do carry conditions before payment can be made. (An example might be that children listed as beneficiaries cannot receive any money until they earn a college degree.) As a result, living trust accounts very often are ineligible for the $100,000-per-beneficiary insurance coverage. Instead, they likely would be insured to $100,000 in
total along with any individually-owned deposits of the person who established the living trust account.

Real-World Example: Two parents established separate living trusts and put the funds in separate bank accounts—the father's with about $190,000, and the mother's with about $170,000. Each parent named the other parent and their four children as beneficiaries. They assumed that each account was insured to $500,000—or $100,000 for each beneficiary. However, their living trust documents included a condition stating that, upon the owner's death, a certain amount would be donated to a charity before the beneficiaries got the remaining funds. The result: When the bank failed, each account was insured to $100,000, leaving $90,000 of the husband's account uninsured and $70,000 of the wife's account uninsured.

The Lessons: "When people go to an attorney to set up a living trust they don't often think about the deposit insurance aspects," says Hugh Eagleton, an FDIC Senior Consumer Affairs Specialist in Washington. "But once you start funding that trust at the bank, the money can quickly go over $100,000." If you're concerned that a living trust account may exceed the insurance limit, now or in the future, you and your attorney should read the FDIC's guidelines on living trusts on the Internet or you can obtain a hard copy from the FDIC's Public Information Center.

If you need additional guidance, call or write the FDIC as listed on the "For More Information" page. FDIC Washington-based attorney Joe DiNuzzo says that the simplest, safest approach you can take is "to just assume that your living trust account will be insured to only $100,000 in the aggregate with any other individual accounts you hold at the bank."

RETIREMENT ACCOUNTS: In general, deposits you keep at a bank for retirement purposes, such as Individual Retirement Accounts (IRAs) and Keoghs, are added together and insured up to $100,000. And your retirement funds are insured separately from your other types of deposits at the same bank. "Even though the rules are pretty clear—anything more than $100,000 in IRAs at one bank is uninsured, period—it's extremely common to find customers with retirement funds over the limit," says the FDIC's Becker. One big reason, he says, is that some people take a lump-sum distribution from a pension fund, often involving a lot of money after many years of work, and they deposit it into one account simply because they didn't realize they could divide that money among different financial institutions.

Also among the common misconceptions, according to Ed Silberhorn, an FDIC consumer affairs specialist in Washington, is that you can get more than $100,000 of coverage for your retirement accounts by dividing the money among multiple accounts, spreading the accounts among different branches of the same institution, or by adding beneficiaries. "These strategies do not increase insurance coverage," he says. "A depositor's self-directed retirement funds at an institution are added together and insured to $100,000. It's about as simple as that."

Real-World Example: A man who worked 50 years to build his retirement nest egg said he believed it was safe to spread more than $200,000 in IRA money among many accounts in one bank. But under the FDIC's rules, all of a depositor's IRAs and other self-directed retirement funds are added together and insured to $100,000, no matter how many different accounts are involved. This depositor had more than $100,000 uninsured when his bank failed.

The Lessons: To fully protect your retirement funds, don't have more than $100,000 of retirement money at any one FDIC-insured institution. If necessary, consider moving some of the money to another retirement account at a different FDIC-insured institution.

JOINT ACCOUNTS. The FDIC greatly simplified the rules in 1999 to insure each person's share in all joint accounts at an institution up to $100,000. Let's say you and a spouse own a $200,000 joint account and neither of you owns other joint accounts at the same insured institution. Under the rules, each of you would be insured for $100,000, and thus, the $200,000 joint account would be fully protected. If you have more than one joint account at an institution and with more than one co-owner, the rules say you cannot be insured for more than $100,000 for your share of all those joint accounts. Even though the joint account rules are straightforward, the recent bank failures indicate that there are still depositors exceeding the insurance limit.

Real-World Example: One family had numerous joint accounts with many different co-owners, totaling about $1.5 million. Three of the co-owners' interests exceeded $100,000, enough to result in more than $800,000 uninsured when the institution failed.

The Lessons: You cannot increase your insurance coverage by adding more names or Social Security numbers to joint accounts, changing the order of the names, changing the wording from "and" to "or" in joint account titles, or opening new joint accounts at different branches of the same bank. The FDIC will simply add your share of all the joint accounts at the same institution and insure the total up to $100,000. (Each person's share is presumed to be equal unless stated otherwise in the deposit account records.) If your share of joint accounts is above $100,000, consider taking action to correct the situation.

FUNDS DEPOSITED BY AN EXECUTOR OR ADMINISTRATOR FOR A DECEASED PERSON'S ESTATE. Deposits into an estate account are added to any other funds in the name of the deceased person at the bank (his or her individual accounts plus any business funds for a sole proprietorship) and the combined total is insured to a maximum of $100,000. But many executors or administrators erroneously believe that the estate accounts qualify for special insurance coverage, maybe even insurance up to $100,000 per beneficiary of the estate. That is incorrect.

Real-World Example: The administrator of an estate deposited nearly $600,000 into a bank and assumed that, because there were seven heirs, the funds were fully protected by FDIC insurance to $700,000 ($100,000 for each beneficiary). But under the deposit insurance rules, the funds were insured to $100,000, leaving about $500,000 uninsured when the bank failed.

The Lessons: If you are the executor or administrator of an estate, don't place estate funds in a bank where the total, including the funds already there in the deceased person's name, would exceed $100,000. Important: Not all deposits owned by the deceased person would be insured as part of his or her estate. For example, if a husband and wife are co-owners of a joint account and the husband dies, unless otherwise specified in the account contract, the entire balance automatically would become the wife's individually-owned funds. Similar rules apply to payable-on-death accounts. However, the FDIC will insure the deceased person's funds as if he or she were still alive for six months after the date of death. This grace period allows extra time for survivors or estate planners to restructure accounts, if necessary.

BANK CDs PURCHASED THROUGH A BROKER. Some people who buy bank certificates of deposit (CDs) from brokers focus on what may be an attractive interest rate but don't pay attention to which institution issued the CD or whether the money was fully insured... until the bank fails. Among the ways people have gotten into trouble: Different brokers sold them CDs at the same bank (most likely because that bank was offering very high interest rates) and the total was more than $100,000. Or, a broker sold a customer a CD from the same institution where that person made deposits directly, and the combination of accounts went over the $100,000 limit.

Real-World Example: A family invested approximately $55,000 in a CD sold by one brokerage firm and another $95,000 in a CD offered by another brokerage firm. Each broker independently opened CDs on the family's behalf at the same bank. When that institution failed, this family was uninsured for $50,000.

The Lessons: "Before you place funds through a broker, know the name of the financial institution and make sure you don't go above the maximum insured amount," cautions Lynette Martin, another Dallas-based insurance claims specialist for the FDIC. What's the best way to get this information? FDIC Washington-based attorney Christopher Hencke says that, before you buy a brokered CD, ask the broker for a copy of the CD or other documentation showing the name of the bank and how the account is titled. With the name of the bank, you can make sure your total deposits at one institution aren't over the insurance limit. And, you'll want to know that the account's title demonstrates that the broker is working as an agent or custodian on your behalf. Otherwise, Hencke says, the FDIC will consider the funds to be owned by the broker and insured to $100,000 in total, even if many different depositors' funds were pooled into one giant CD.

Final Thoughts

"Customers often think that the FDIC has the option to cover their uninsured deposits if they can show they intended for their funds to be fully covered, but the deposit insurance laws don't give us that flexibility," says Kathleen Nagle of the agency's Division of Compliance and Consumer Affairs in Washington. "The FDIC cannot pay depositors more than the law permits. So if you want to be sure that any deposits over $100,000 are fully insured, you must learn about the insurance rules and how they apply to your specific situation." The bottom line: The FDIC is here to protect you, but you are responsible for protecting yourself, too.

The FDIC is here to protect you, but you are responsible for protecting yourself, too.

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