In other words, you do not need to worry about that coverage going away at the end of this year. Coverage was also extended to $250,000 through December 2013 for federally-insured credit union deposits through the National Credit Union Administration (NCUA).
The increased limit is large enough that with just a little advance planning, there’s no reason whatsoever for middle-class Americans to lose a dime from putting money into FDIC-insured banks or NCUA-insured credit unions.
In fact, by intelligently combining accounts having different types of ownership, you and your family and your business combined can effectively get a lot more than $250,000 in insurance coverage.
But — there are some gotchas that consumers and small business owners should watch out for — because under certain circumstances, you may have LESS coverage than you think you have. Before I get into those gotchas, let’s take a look at how FDIC insurance works and the critical role it plays.
FDIC Insurance in Practice
From the typical consumer or small business owner perspective, FDIC insurance is pretty simple. As long as your deposits are under the FDIC insurance limits, there’s zilch chance of losing any money you have in the bank. The Federal government, which stands behind the Federal Deposit Insurance Corporation (FDIC), will repay your money in the event your bank fails.
In practice, chances are you will never even have to make a claim to the FDIC because the government will find another stronger bank to take over your failed bank. From your perspective it will be pretty painless — just one bank buying another. Usually the failing bank is seized late on a Friday afternoon. On Monday morning the doors open with a new name on the bank — the name of the new institution. Your insured money is still there for you. The only difference is that you are dealing with a new banking institution. But the reason it’s business as usual for you is due to the government standing behind bank deposits.
The losers are those who have deposits exceeding the FDIC limits. If you happen to be so unlucky as to have deposits that go above the FDIC limits, your money will not be immediately available to you. You become a creditor of a bankrupt institution.
That’s what happened to 30 uninsured depositors who had combined deposits of $1.2 Million in Metropolitan Savings Bank when that institution was seized back in 2007. Those 30 depositors had an average of $40,000 above the FDIC limits. Uninsured depositors may only get a fraction of their money back, years later — or may never get any of it back. That’s why FDIC insurance is so important … to avoid ending up like one of those 30 uninsured depositors.
Propping Up Public Confidence
On a macro level, FDIC insurance is all about maintaining public confidence in the banking system.
Last year I wrote about the valuable role that the increased FDIC insurance coverage played in maintaining public confidence in the midst of the financial crisis of 2008. It avoided massive bank runs by consumer depositors.
True, there were a few scattered reports of depositors lining up to demand their money from a few troubled banks. But those were isolated instances — certainly nothing on a large scale. For the most part Americans left their money in banks and were not clamoring to get it out — because of their confidence in FDIC insurance.
Ironically, the FDIC insurance has become so reassuring to the public that money tends to flow in to the weakest banks because depositors are chasing the highest interest rates. Americans look at the interest rate and actually pour money into troubled institutions in their quest for a higher return — a phenomenon Forbes recently dubbed the reverse bank run.
When $250,000 FDIC Coverage is not $250,000 - The Gotchas
So, the basic FDIC coverage is $250,000 per depositor. But under certain circumstances and depending on the type of account and how ownership is held, a family with several accounts in the same bank can have considerably more than $250,000 insured. For instance, a husband and wife with 3 children could have up to $2 Million of coverage, depending on the legal ownership forms of the accounts. Business accounts are eligible for coverage separate and apart from your personal accounts.
That can be very reassuring … except when circumstances change, or you are mistaken to begin with.
In some circumstances you may think you have more money covered by federal insurance than you actually do. Here are 5 “gotchas” for small business owners to watch out for:
(1) Your business accounts are treated as individual accounts. A lot of small business owners will use the same bank for personal accounts as well as business accounts. That may be OK as long as your business account is truly a business account. You see, often small business owners will set up a checking account and a reserve/savings account as a sole proprietor. As a sole proprietor, your business account will be treated as a personal account for FDIC coverage purposes. On the other hand, corporate, partnership and unincorporated association accounts are not aggregated with personal accounts, and get additional FDIC coverage. Hint: if you are not sure, look first at whether your business is set up a separate legal entity, such as a corporation, partnership or LLC. Then look at whether the account was set up in the name of the business, including using an EIN (employer identification number) for the business, instead of the owner’s social security number as in the case of a sole proprietorship.
(2) One bank is bought by another bank. One tried and true method to avoid being uninsured or underinsured by FDIC is to spread your money around to multiple banks, each of which is separately insured. But what if you had spread your money around to Bank A and to Bank X, but at some point Bank X merges with Bank A? All your money ends up in the same institution and could exceed FDIC limits. Lesson: recalculate the FDIC coverage if you get a notice that your bank has merged or is bought out. Move some of your money if necessary within 6 months of the merger or buy out (FDIC coverage continues for 6 months after a merger — so you have a temporary cushion).
(3) You have funds in a bank-provided insurance policy, mutual fund or other non-deposit account. FDIC insurance only applies to deposit accounts such as checking, savings and certificates of deposit. Go here for a complete list of the types of investments covered and not covered by FDIC insurance.
(4) You have funds in one of the 160-privately insured credit unions. Remember I said above that credit union deposits are federally insured through a similar fund run by the NCUA? Well, that’s true for all but 160 state-chartered credit unions in the United States. Those 160 credit unions are covered by a private insurance fund, known as American Share Insurance (ASI) coverage. If your credit union does not qualify for NCUA coverage and instead is covered by ASI, it doesn’t necessarily mean trouble. It just means your deposits are not backed by the U.S. government — be aware of the distinction.
(5) You have an employee benefit fund account in the bank. An employee benefit account (such as a pension plan) is insured separately from personal accounts — that’s the good news. However, each person’s interest in the employee benefit account is calculated separately to determine the extent to which their interest is insured. The rules are rather complex and I will simply refer you to the FDIC website and the calculation given there, to determine whether every employee (including the business owner) has their interest in the benefit fund fully covered.
Bottom line — if you have business and personal funds of your family exceeding $250,000 in banks and credit unions, do your due diligence. Use this FDIC insurance estimator (or the similar one at the NCUA site) to determine how much coverage you truly have, and avoid the gotchas. Read the information on the FDIC or NCUA websites in detail.