FDIC | SIPC – And How Your Accounts Are Protected

With all the recent chaos and uncertainty in the banking world, I thought it would be good to review the topics of FDIC and SIPC coverage, and how your accounts are protected. Let’s start with a basic overview of each.

Federal Deposit Insurance Corporation (FDIC)

Given the recent collapse of Silicon Valley Bank and Signature Bank, FDIC coverage has been in the news a lot lately. And for good reason – it’s what insures our cash deposited with the banks, to a certain extent.

The FDIC—or Federal Deposit Insurance Corporation—is a U.S. federal agency that protects you up to certain limits against the loss of your deposit accounts (such as checking and savings) if your FDIC-Insured bank fails.

The basic FDIC insurance amount for deposit accounts is up to $250,000 per depositor, per insured bank, based on ownership type and $250,000 per owner per insured bank for self-directed retirement accounts deposited at an insured bank. These insurance limits include principal and accrued interest. By spreading your money around different account types and multiple banks, you could easily amass millions in FDIC coverage if needed. For more explanation on this, read my article on understanding FDIC insurance.

The FDIC does not insure money invested in stocks, bonds, mutual funds, life insurance policies, annuities, municipal securities, and money market funds, even if these investments were bought from an insured bank.

Many of our clients have some level of cash in Schwab’s bank deposits as this is their liquid sweep option, but we consistently and methodically monitor our clients’ cash levels to ensure full protection under FDIC limits. Any excess cash above the FDIC protection is placed in a higher-yielding, safe money market fund.

*Fidelity does not have a banking arm and therefore most sweep cash can be invested in money market funds. We primarily use their core government money fund, which is extremely safe.

Now on to the more misunderstood coverage – SIPC.

I think many investors are under the impression that if a brokerage company fails (bankruptcy) that SIPC is the only chance they have of getting their money back. Nothing could be further from the truth.

Securities Investor Protection Corporation (SIPC)

Major brokerage companies like Charles Schwab and Fidelity are members of the Securities Investor Protection Corporation (SIPC), which provides protection for securities and cash in client brokerage accounts, including those held by clients of investment advisors. SIPC protections are activated in the rare event that the broker-dealer fails (bankruptcy) and client assets are missing due to fraud or other causes.

Here’s where I see SIPC often misunderstood. I think many investors are under the impression that if a brokerage company fails (bankruptcy) that SIPC is the only chance they have of getting their money back. Nothing could be further from the truth.

Read that bold sentence above one more time: and client assets are missing due to fraud or other causes.

Let’s put this in plain English – Schwab / Fidelity would have to commit fraud (basically steal) and misappropriate your money for SIPC to ever be necessary. That scenario is so far-fetched that I don’t waste much brain power thinking about it. And remember, even with bank failures like Silicon Valley and Signature there was no fraud involved. Their management teams just made very stupid decisions.

I want to be very clear on something – your securities, like stocks, bonds, mutual funds, exchange-traded funds, or money market funds—held at custodians like Schwab and Fidelity, are yours. The SEC’s Customer Protection Rule safeguards customer assets at brokerage firms by preventing firms from using customer assets to finance their own proprietary businesses.

Your fully paid securities are segregated from other brokerage firm assets and held at third party depository institutions and custodians. There are reporting and auditing requirements in place by government regulators to help ensure all broker-dealers comply with this rule. In the extremely unlikely event that Schwab or Fidelity should become insolvent, these segregated securities are not available to general creditors and are protected against creditors’ claims.

How does SIPC coverage work?

So, now that we’ve covered what it would take for SIPC to even kick in, how does it actually work? SIPC provides up to $500,000 of protection for brokerage accounts held in each separate capacity (e.g., joint tenant or sole owner), with a limit of $250,000 for claims of uninvested cash balances. These limits do not mean that the account will only receive up to $500,000 of their invested securities. Rather, in a SIPC customer proceeding, the account will receive a pro-rata share of all client assets recovered in liquidation then will receive up to $500,000 from SIPC to make up any difference that exists.

According to SIPC, most broker-dealer failures happen with no securities missing. Since their inception over 50 years ago, 99% of eligible investors got all of their investments back in the failed brokerage firms cases that it has handled.

IN SUMMARY

I know we live in a crazy world and anything can happen. But, I hope this explanation of how your accounts are protected provides a little peace of mind.