The Intersection of Bank Failure and FDIC Insurance

I remember the shock I felt in 2008 when I learned that my bank, Washington Mutual, collapsed after a 9-day bank run. Thankfully, J.P. Morgan Chase bought the banking subsidiaries and most depositors continued with the new bank as though nothing had happened. Fifteen years later, not one, but three, banks have failed in one week’s time. Leaders are working hard to differentiate the events of the last week from those in 2008, but similarities exist.

Trouble started when Silvergate, a California-based bank that loaned funds to cryptocurrency companies, announced that it would liquidate its assets and cease operations. Concern grew when a few days later the Federal Deposit Insurance Company (“FDIC”) took over Silicon Valley Bank, taking almost $175 billion in customer deposits under its control. A large number of uninsured deposits, many held by small businesses, only exacerbated that concern sending shockwaves through the banking industry over the weekend when banks are typically closed. That fear lead to a Sunday night announcement that yet another bank, Signature Bank, shuttered its doors. The Federal Reserve, Treasury, and FDIC gave a joint statement that “depositors will have access to all of their money starting Monday, March 13” to calm investors and prevent panic from reverberating throughout the banking industry. If investors feared for the safety of their deposits in other banks and began to withdraw their money that could prompt a system-wide failure. The aggressive move of covering all deposits, even those that exceed the FDIC insured amount, means that the regulators have decided the risk to the banking system merits invoking an exception to the rule that the FDIC covers the failure by the least expensive means. The Deposit Insurance Fund will cover the funds not covered by the FDIC through the fees it collects from the banking industry.

Interesting, no doubt, but what does all of this have to do with Estate Planning? A great deal, it turns out. I have fielded many a question from a client regarding how much of their funds will be insured by the FDIC, especially when the plan involves one or more trusts. Last year, the FDIC issued updated rules regarding insured accounts designed to simplify the system.

Under the current rules, which remain in place until April 1, 2024, the FDIC insures deposits up to $250,000 per depositor, per ownership category, per institution. Assume that Johnny has $250,000 in BigBank and no other accounts anywhere. Should BigBank fail, the FDIC covers the entire amount. The same holds true if instead, Johnny titled his account in his revocable trust. Things change a bit if Johnny dies. Upon Johnny’s death, the assets in trust will pass to his daughter, Lyla. In that situation, the FDIC would insure up to $250,000 per institution, per trust beneficiary, up to a maximum of 5 beneficiaries for a total of $1,250,000. The rules look to the primary beneficiaries of the trust, which the FDIC defines as those individuals who would take upon the death of the grantor of the trust. The rules do not count contingent beneficiaries and more remote beneficiaries. In the above example, one beneficiary means that the FDIC protects the entire $250,000.

If Johnny had $500,000 in the account with BigBank, the FDIC would protect only $250,000. He could, however, transfer $250,000 to HugeBank thereby doubling the protected amount because it’s at a different institution. If Johnny had 5 children, all of whom were the beneficiaries of his revocable trust upon his death, then the FCID would insure $1,250,000 (5 x $250,000). If he had funds in excess of that $1,250,000, then he should transfer the overage to a new bank, keeping in mind that the FDIC insures no more than $250,000, per institution, per beneficiary, up to a maximum of $1,250,000 regardless of additional beneficiaries or funds. If Johnny were married and had a joint revocable trust, assuming that five beneficiaries took upon the death of both grantors, then the FDIC would cover up to $2,500,000 at any one institution.

Now assume that Johnny created an irrevocable trust. FDIC insurance works the same for all identified non-contingent beneficiaries as it does for a revocable trust covering up to $250,000 per institution, per trust beneficiary, up to a maximum of 5 beneficiaries for a total of $1,250,000. If the trust names contingent beneficiaries, however, then the rules add those contingent interests together and insure up to a maximum of $250,000, regardless of the number of beneficiaries or the allocation of the funds among the beneficiaries. To demonstrate, let’s assume that Johnny has 5 children, 4 of whom hold contingent interests in the trust making Lyla’s interest the only non-contingent interest. If Johnny has $600,000 in BigBank, the FDIC will cover only $500,000, $250,000 for Lyla, and $250,000 for the collective contingent interests, even though there are 4 beneficiaries.

Note that if the funds in an account represent both contingent and non-contingent interests, then the FDIC would separate those interests and apply the rules as described above. It’s easy to see how multiple trusts complicate these rules. Interestingly, according to the FDIC, it receives more inquiries related to insurance coverage for trusts than all other types of deposits combined. As noted earlier, to simplify the rules, the FDIC issued new rules on January 21, 2022, with a delayed effective date of April 1, 2024.

The new rules merge the categories for revocable and irrevocable trusts and use a simpler, more consistent approach to determine coverage. Now, each grantor’s trust deposits will be insured up to the standard maximum amount of $250,000, multiplied by the number of beneficiaries of the trust, not to exceed five. It no longer matters whether the trust is revocable or irrevocable or whether the interests are contingent or fixed. These rules effectively limit coverage for a grantor’s deposits at each institution to $1,250,000 for a single grantor trust and $2,500,000 for a joint trust, assuming that there are five beneficiaries of such trusts. The streamlined rules provide depositors and bankers guidance that’s easy to understand and will facilitate the prompt payment of deposit insurance, when necessary.

While depositors in Silicon Valley Bank were covered in excess of FDIC coverage, there’s no guarantee the FDIC will cover depositors in excess of the insurance coverage next time. If you are concerned about FDIC coverage for trust accounts, or in general, let me know. I can help you understand current coverage levels and advise you regarding any moves that you should make now or in the future to receive maximum FDIC insurance coverage.