Wednesday, August 20, 2008

Caution: FDIC Misinformation is Rampant

With the recent string of bank failures, there has been a renewed interest in people seeking information about FDIC (Federal Deposit Insurance Corporation) insurance limits. Unfortunately, I have found that there is rampant misinformation about FDIC insurance, even among usually reputable sources. Following this misinformation can and has cost depositors dearly -- some losing a significant portion of their savings when their bank failed.

Everyone knows that an individual bank account is insured to $100,000. However, probably the biggest misconception is that you can increase this limit by opening different accounts at the same financial institution -- for example, opening a savings, CD, and checking account at the same bank. This assertion is simply not correct. If the new accounts are in the same ownership category (i.e. individual accounts), the insurance FDIC limit is still $100,000 regardless of the number of accounts you have.

The $100,000 FDIC limit can, however, be bypassed by opening a joint account. Individual and joint accounts are considered different "ownership categories" by the FDIC, and are insured separately. In our personal situation, my wife has an individual account at a bank, and we have a joint account at the same institution (which I won't name here). To confirm my understanding, I called the bank's customer service number, and then Emailed them to ask what the FDIC limits are in our case. Surprisingly, I received two different, incorrect answers to my question. I then went to the branch office and talked to a teller whose response was something to the effect of "Duh, I don't know. Let me ask a supervisor."

Finally, I sat down down with a senior bank representative at the branch who gave me the correct answers: My wife's account is insured to $100,000 and our joint account is insured to $200,000 for a total of $300,000. I have confirmed this finding with the FDIC website as being correct.

Imagine my surprise when on the morning of July 27, I opened a copy of my local newspaper, the San Jose Mercury News (usually a reputable source), and read an article written by noted financial columnist Kathy Kristof depicting a nearly identical situation where she claimed that a portion of the wife's deposits would be uninsured. I leaped out of my seat and exclaimed, "That article is wrong!" I was about to write message to the author pointing out her error, but I did some research and found that the same article was published in the Los Angeles Times a week earlier. The Times subsequently published this correction to their article:

"The Personal Finance column in Business on Sunday erred in how it described insurance of individual and joint accounts. It said that each person's interest in individual and joint accounts is added together to determine that individual's insurance coverage. In fact, individual and joint accounts are insured separately. Therefore, you could have an individual account worth $100,000 and a joint interest in a $100,000 joint account and all of your deposits would be fully insured."

However, a version of the same article on the S.J. Mercury News website remains with the erroneous information. This is true, even though the L.A. Times published the correction several days before the Mercury reprinted this story.

Another ownership category recognized by the FDIC is called a revocable trust account. In general, these accounts are titled with the account owner's name, and either POD (payable-on-death) or ITF (in trust for) a qualifying named beneficiary. The FDIC has very specific rules on who can qualify as a beneficiary. For example, a grandchild, parent, or sibling can qualify. However, nieces, nephews, in-laws, or domestic partners would not qualify. I advise that readers should check with the FDIC for the specifics on who can be named as a beneficiary.

Revocable trust accounts (also called testamentary accounts) are insured separately from individual, or joint accounts. Each owner of a POD account is insured up to $100,000 for each qualifying beneficiary. For example, a couple with one child can establish a POD account for their child and it would be insured separately from the other ownership categories up to $200,000.

A fellow blogger referred me to an article published at the usually reputable site which also talks about these types of accounts. In this article, Bankrate stated that "Couples can set up an in-trust or testamentary trust account for their children for a maximum of $600,000 in insurance coverage." Unfortunately this is an oversimplification, and after puzzling for a while, I figured out how Bankrate got it wrong. The FDIC publication Your Insured Deposits gives several examples of how a couple with three children can setup a POD account. In this case, the maximum insured amount is indeed $600,000. However, this is not the general case as it ONLY applies to two-parent families with three children. Depending the number of account owners and qualifying dependents, this limit may be higher or lower. For example, a couple with four children could setup an account with $800,000 in FDIC protection; a couple with two kids would be limited to $400,000 in a similar testamentary account.

Similarly, a household headed by a single parent, or by same-sex partners would have a different maximum FDIC limit. It is irresponsible for Bankrate to make
such broad generalizations because everybody's personal situation is different. Clearly, Bankrate's information here is outdated (it was published in 1999), and I intend to contact them about their oversight.

So what is a high net worth depositor supposed to do about the FDIC limits? First of all, don't assume that any information you receive (even from your banker) is correct. I've read several anecdotal accounts of people who were burned in the recent IndyMac Bank failure. They claim that the bank said their accounts were covered by FDIC, but it turns out that they were not. I am starting to believe that they folks were indeed given wrong information from their bank. For the record, an FDIC press release stated that IndyMac had "about $1 billion of potentially uninsured deposits held by approximately 10,000 depositors." Or, about $100,000 of uninsured deposits on average.

Secondly, understand that financial writers and bloggers may not have similar finances to yourself, and any generalizations made may not be applicable to your particular situation. Many financial sites have a disclaimer that says something to the effect that what they publish shouldn't be construed as actual financial advice. This is with good reason: sometimes they get the facts wrong.

In an effort to be completely honest, I tell my readers this: DON'T EVEN TAKE MY WORD ON IT! Although everything in this post is believed to be is currently accurate (in August 2008), it is very possible that you are reading this blog post years later. FDIC rules and regulations are subject to change, and there can be no guaranty that anything you read will still be true in the future.

Lastly, and most importantly, the most accurate source of information about FDIC insurance is the FDIC website itself. For any readers with significant assets in bank accounts, I encourage them to carefully study the FDIC rules, and run your specific scenario through the FDIC's Electronic Deposit Insurance Estimator.

This tool will help to determine and confirm your actual deposit insurance limits. Good luck to you.


Friday, August 1, 2008

Single Step Personal Finance Challenge

Andy from Saving to Invest, tagged me with the "Single Step Personal Finance Challenge" blog meme started by Mrs. Micah. The challenge is to "find one step you can take to make your financial system better or more organized."

Andy's single step was to open up a Roth IRA account. My only real commentary on this is that I typically contradict the common investment advice to contribute early to an IRA. I don't contribute to my Roth IRA until the end of the tax year so that I can know for sure that I qualify. A person's eligibility to contribute to a Roth is determined by their AGI in the contribution year. Since it is impossible to completely predict future income, there is always a possibility that one will exceed the Roth IRA income limit. If this happens, one must either withdraw the excess, or face an IRS penalty. In either case, this would involve some messy dealings with the IRA custodian.

Anyway, on to my single step... Readers who saw my post about Money Market Interest Rates are aware that I was considering closing one or more of my bank accounts that is paying me a lower interest rate. I've done just that. I closed my Guaranty Bank money market account, and moved the money to Washington Mutual. In one step, I am now earning 1% more interest on my money.

Although I agreed to humor Andy and Mrs. Micah with a response, I thought that this blog tag meme was a somewhat silly one, and have decided not to tag anybody else.