Deposit Insurance Offers a Safe Haven

Good times or bad, it is vital for investors to hold cash reserves. Federal deposit insurance provides an extra layer of comfort, so it is vital for CPA advisors to know the rules and be able to explain them.

The Federal Deposit Insurance Corporation (FDIC) guarantees certain amounts held in most banks and savings associations; the National Credit Union Administration (NCUA) does the same for credit unions. If an institution posts an FDIC or NCUA sign, deposits there are covered.

This article explains some of the different kinds of accounts eligible for federal deposit insurance. A sample family portfolio of accounts discussed below is available in the Exhibit.

Incomplete Coverage

These days, many banks offer more than merely deposits. Among the available options, federal insurance covers checking accounts, savings accounts, and certificates of deposit (CD). If a bank or credit union fails, the insurance coverage kicks in. On the other hand, investments and insurance products such as mutual funds and annuities are not covered by federal insurance, even if they are purchased at an insured bank.

Federal insurance covers up to $250,000 per depositor per bank. Thus, if John Smith has $15,000 in a checking account, $40,000 in a savings account, and $100,000 in CDs, all at the same bank, his entire $155,000 will be covered if that bank fails. There might be a straight payout to each depositor, or equivalent accounts might be opened at another bank that is financially sound.

Multiple Choices

Note that the $250,000 limit is per person, not per family. John Smith might have $250,000 in his personal deposit accounts, while his wife Mary has another $250,000 in her name. Altogether, this couple would have $500,000 of federal deposit insurance.

In addition, the FDIC combines each co-owner's shares of all joint accounts and insures each co-owner's total up to $250,000. John's 50% ownership share in a single joint account will go up to $250,000; Mary's 50% ownership share in that same joint account also will go up to $250,000. Thus, a joint account of $500,000 held by this couple would also be fully insured-on top of the coverage for their individual accounts.

As explained, the Smiths could have up to $1 million in their personal and joint deposits at the same bank, fully covered by federal insurance if the bank fails. In addition, their retirement accounts, such as IRAs, also could be held at that bank, insured up to $250,000 per account owner.

Indeed, the breadth of federal deposit insurance may be surprising. For example, this coverage also applies to health savings accounts (HSA) that hold deposits rather than investments. If these tax-advantaged holdings (e.g., tax-deductible contributions, tax-free interest compounding, tax-free qualified withdrawals) are held at an insured bank, deposit insurance will be applied to the usual limits; if beneficiaries are named, the HSA will be treated as a revocable trust account, as explained below.

Similarly, fiduciary accounts, such as those established under the Uniform Transfers to Minors Act, are federally protected if they hold deposits at a qualifying financial institution.

Trust Accounts

Besides all the various qualifying accounts mentioned above, trust accounts also are covered. As might be expected, these trust accounts must hold the types of bank deposits qualifying for insurance. Often they are known as "Totten trusts," "payable on death" accounts, or "in trust for" accounts. Under any of these names, creating an insured trust account is simple. The creator simply signs the bank's signature card; there is no need to pay an attorney. One or more beneficiaries can be named.

Once a trust account is in place, the creator remains in control. Typically, bank trust accounts are revocable, so the creator can tap the account for current cash flow or terminate the agreement and take the cash elsewhere, subject to any terms applying to the underlying deposit. (Different rules apply to irrevocable trust accounts.)

When the trust creator dies, the money automatically will go to the beneficiaries, without the time and expense of passing through probate. Therefore, using such trust accounts is an efficient way to transfer bank deposits to heirs upon the account owner's death.

Increased Insurance

For federal insurance purposes, using trust accounts may raise the deposit limit, as the standard $250,000 ceiling is applied per beneficiary, after omitting the account owner. Suppose Ann Baker puts $500,000 into a bank CD; she signs a trust account agreement to hold the CD and names her two children as the beneficiaries. Now the insurance coverage goes up to $500,000 ($250,000 x 2), for the two beneficiaries. Moreover, if the bank fails and a payout results, the insurance proceeds would go to Ann, assuming she is still alive, rather than to her trust account beneficiaries.

Trust account coverage falls into a separate category. If Ann also has a nontrust account at the same bank, in her name, the insurance coverage in case of a failure would be worth as much as $750,000: up to $500,000 to Ann, as the owner of a trust account with two beneficiaries, and another $250,000 to Ann, for the account in her own name.

A joint trust account may effectively double the federal deposit insurance. Suppose Keith Long and his wife Melanie invest $1 million in a CD, then create a trust account to hold the CD and name their three children as beneficiaries. With two owners and three beneficiaries, they are entitled to six times the $250,000 federal deposit insurance ceiling limit, or $1.5 million; thus, the $1 million trust account would have complete insurance coverage.

When a bank trust account has been created, neither the named beneficiaries nor their creditors will have access to that money. The creator can change beneficiaries, if that is desired, but once the trust creator dies, the funds in the account will go to the beneficiaries and no one else; the decedent's will cannot change this. Consequently, astute estate planning calls for periodic review of all beneficiary designations, including those named on bank trust accounts.

Safety and Simplicity

Although 2020 has been marked by widespread public health crises, economic turmoil, and stock market weakness, bank failures have been modest so far. Overall, as of this writing, the banking sector has held up well.

Nevertheless, the presence of federal deposit insurance provides a great deal of assurance, especially for people who keep very large sums in what are perceived to be low-risk deposit accounts. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed this year to support economic recovery, authorizes the FDIC to guarantee obligations of solvent insured depository institutions without a maximum guarantee until December 31, 2020, so even larger accounts may be covered temporarily.

Moreover, clients with moderate amounts of federally insured deposits also may find bank trust accounts to be valuable vehicles. Without going to the time and expense of hiring an attorney, depositors can hold bank trust accounts that will pass quickly to beneficiaries upon the creator's death, bypassing probate. Therefore, bank trust accounts can play a role in the financial plans of many individuals.

For more information, a "Your Insured Deposits" brochure with comprehensive information about federal deposit insurance is available from the FDIC (https://bit.ly/2WiFxto). □

Sidney Kess, JD, LLM, CPA, is of counsel to Kostelanetz & Fink and a senior consultant to Citrin Cooperman & Co., LLP. He is a member of the NYSSCPA Hall of Fame and was awarded the Society's Outstanding CPA in Education Award in May 2015. He is also a member of The CPA Journal Editorial Advisory Board. Julie Welch, CPA, PFS, CFP, is the managing shareholder at Meara Welch Browne PC, Leawood, Kan.