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Jun 29, 2009 -

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.

Conclusion

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.