With the sudden closures of some major regional and industry-specific banks, many people are worried about their FDIC coverages for accounts held in trust.
This is a good opportunity to review the rules when it comes to FDIC insurance and trusts. In fact, the FDIC approved changes, on January 21, 2022, to the deposit insurance rules for revocable trust accounts (including formal trusts, POD/ITF), irrevocable trust accounts, and mortgage servicing accounts. These changes take effect on April 1, 2024.
In this article, I will focus only on the FDIC rules as it relates to revocable trust and irrevocable trust accounts. I will cover both the existing rules and the new rules that will be effective beginning next year.
In general, joint trusts can offer an expanded FDIC coverage limit compared to joint ownership of the same account, where the trust lists successor beneficiaries.
CHANGES
For most trust depositors (i.e., those with less than $1,250,000), the FDIC expects the coverage levels to be unchanged. For those depositors with more than $1,250,000 per owner at one institution, there could be instances of reduced coverage. And for some depositors, especially those with irrevocable trusts, the coverage will expand.
Under existing law, the FDIC limit for trusts depends on whether the trust is revocable or irrevocable, whether the trust beneficiary is primary or contingent, whether there are six beneficiaries or more named in the trust instrument, and whether some beneficiaries receive an unequal amount. I will review all of this in this article.
Under the new rules, however, it will make no difference whether the trust account is revocable or irrevocable, and it will make no difference how many beneficiaries there are, whether a beneficiary is primary or contingent, or the amount that each beneficiary will receive.
TERMINOLOGY
A grantor is a person who creates a trust. In a joint trust among a married couple, there are two grantors. In an individual trust, there is one grantor.
A beneficiary is the person who the trust assets belong to. However, when it comes to FDIC insurance and trusts, the grantors are ignored when counting beneficiaries. In other words, the only beneficiaries that matter, when calculating FDIC insurance for trusts, are those who inherit once the grantors have all passed away.
NEW RULES – EFFECTIVE APRIL 1, 2024
Under the new rules, a simple calculation will be used across the board, regardless of the type of trust created.
Beginning April 1, 2024, each grantor’s trust deposits will be insured in an amount up to the standard maximum deposit insurance amount (SMDI) (currently $250,000) multiplied by the number of trust beneficiaries, not to exceed five. This, in effect, will limit coverage for a grantor’s trust deposits at each insured institution (IDI) to a total of $1,250,000; in other words, maximum coverage of $250,000 per beneficiary for up to five beneficiaries.
The grantors, themselves, are ignored when it comes to counting beneficiaries. Moreover, the five beneficiary maximum includes only those individuals who get paid at the death of the owner(s) (hereinafter, “primary beneficiary”). In other words, if a trust pays out to two children, and then to three grandchildren at the death of the two children, only the two children are counted as beneficiaries. However, if both children do in fact die, then the grandchildren will be counted only at that time.
Example 1:
John and Jane create a joint trust account, which name their 2 kids as beneficiaries and their 3 grandkids as contingent beneficiaries. If the bank fails and the 2 kids are alive, what is the FDIC insured amount?
Answer: Up to $1,000,000. John and Jane are 2 grantors, each with up to $500,000 of insurance coverage (i.e., each grantor can apply $250,000 in coverage to a maximum of 2 beneficiaries, not to the 3 contingent beneficiaries). It does not matter whether the trust is revocable or irrevocable. It does not matter if the children get unequal amounts.
Example 2:
John and Jane have another joint trust account at the same bank, where they name their 3 grandkids as primary beneficiaries, and their 3 nieces as contingent beneficiaries. If the bank fails and the 3 grandkids are alive, what is the FDIC insured amount?
Answer: Up to $1,500,000. John and Jane are 2 grantors, each with up to $750,000 of insurance coverage (i.e., each grantor can apply $250,000 in coverage to a maximum of 3 beneficiaries, not to the 3 contingent beneficiaries). It does not matter whether the trust is revocable or irrevocable. It does not matter if the children get unequal amounts.
Combining the two examples above, both trusts created by John and Jane at the same financial institution are aggregated. Thus, under the new rules, the maximum coverage at each financial institution for all trusts created by a single grantor is $1,250,000 (and $2,500,000 for both).
OLD RULES FOR REVOCABLE TRUSTS – STILL EFFECTIVE UNTIL APRIL 1, 2024
Under the existing rules, which are set to be replaced on April 1, 2024, the FDIC limits depend on whether a trust is revocable, irrevocable, whether beneficiaries are primary or contingent, how many beneficiaries are named in the trust, and whether some beneficiaries get more than others.
First, when it comes to counting beneficiaries, the existing rules ignore the grantors and only look to the first line of beneficiaries (called primary beneficiaries) who will inherit when both grantors have passed away. Contingencies are disregarded so long as the primary beneficiaries are alive when the bank fails. Therefore, a trust will be regarded as having only one beneficiary even though it’s a joint trust that pays to one person at the death of both grantors, and even if the one beneficiary may not receive everything because an independent trustee is in charge of determining the amounts. Moreover, for FDIC coverage purposes, a beneficiary generally must be an individual, charity, or non-profit.
Secondly, if 5 or fewer beneficiaries have been named, the total coverage is $250,000 multiplied by the total number of named beneficiaries (obviously capped at 5). It does not matter if the beneficiaries receive an equal amount or will be receiving unequal distributions. In this regard, the new rules do not alter this old result.
Third, in identifying beneficiaries, the FDIC does not distinguish between beneficiaries who shall receive distributions “off the top” and beneficiaries who shall receive a percentage or portion of remaining funds. If a living trust agreement provides for payments to certain people before distribution of the balance of the trust funds, those receiving the specific distributions, as well as those receiving the balance of the trust assets, all will be deemed beneficiaries for deposit insurance purposes. However, a beneficiary who receives an “off the top” distribution and also shares in the residual deposit funds cannot be counted twice.
MORE THAN 5 BENEFECIARIES
Under the existing rules, if more than 5 beneficiaries are named in the trust, the total coverage is the greater of: (1) $1,250,000; or (2) the total of the interests of each beneficiary, with each such interest limited to $250,000.
Recall that where there are multiple grantors of a trust, the limits listed above apply to each grantor. Recall further that the grantors are not included in the calculation of the number of unique beneficiaries.
Example 3: John and Jane create a joint trust account, which name 8 people as beneficiaries. Seven of the eight beneficiaries will receive 10% but one of the beneficiaries will receive 30%. If the bank fails and there is $3,000,000, what is the FDIC insured amount?
Answer: $4,000,000. According to the trust, 7 of the 8 beneficiaries will receive $300,000 each, and the 8th beneficiary will receive $900,000. This means that the “total of the interests of each beneficiary with such interest limited to $250,000” is $2,000,000 (7 of the 8 beneficiaries will be capped at $250,000 each, which equals $1,750,000 in coverage, and the 8th beneficiary will be capped at $250,000). Because there are two grantors, the $2,000,000 in coverage applies to each grantor. Because $4,000,000 is greater than $1,250,000, this will be the covered amount.
Note that under the new rules, the coverage decreases to $2,500,000, because there is coverage of $250,000 multiplied by a maximum of 5 beneficiaries, multiplied by two grantors. This is also the maximum for that one institution.
Finally, under the current rules, even though a revocable trust becomes irrevocable due to the death of the grantor, the trust’s deposit may continue to be insured under the revocable trust rules and not under the more stringent irrevocable trust rules, as explained below.
OLD RULES FOR IRREVOCABLE TRUSTS – STILL EFFECTIVE UNTIL APRIL 1, 2024
Under the existing rules, which are set to be replaced on April 1, 2024, the FDIC limits for irrevocable trusts depend on whether contingencies apply to a beneficiary’s share. In other words, coverage only applies to primary (non-contingent) beneficiaries who receive guaranteed payments at the death of the grantor(s). If the trust includes only primary beneficiaries, with no contingencies attached, then $250,000 applies in coverage to each unique, non-contingent beneficiary, per grantor, with no limit.
This in fact is rare though. Many irrevocable trusts have contingencies for the beneficiary. For example, when the funds in a single irrevocable trust account represent both contingent interests and non-contingent interests, the FDIC will separate the two types of funds before applying the rules above.
Examples of “contingent” interests include whether a trustee has discretion to decide what, if any, to distribute to a beneficiary, whether the grantor has a right to change the amount a beneficiary will receive, or whether the beneficiary has to do something to get the money. In such cases, if the beneficiaries may not receive their interests because of some event or condition, all the contingent beneficiaries’ interests will be added together and insured up to $250,000. Therefore, it is advisable for trustees of an irrevocable trust to deposit no more than $250,000 of the trust’s assets with any one insured institution.
Moreover, in the rare case that a grantor retains an interest in the irrevocable trust, the coverage is limited to $250,000.
Therefore, the new rules will make coverage better for most irrevocable trusts which are currently, in practice, capped at $250,000.
CONCLUSION
With banks failing currently, the difference between the existing rules and the new rules can be dramatic. If a bank fails currently, many irrevocable trusts will be insured only up to $250,000 regardless of the number of beneficiaries, if contingencies apply to those named beneficiaries. On the other hand, under existing rules, revocable trusts with 6 or more beneficiaries, all of which receive equal distributions, are capped at $250,000 per beneficiary per grantor, with no upper limit.
Thus, the new rules will create some losers and some winners when it takes effect. Ultimately, if banks continue to fail, it’s hard to see how anyone will see it as a win.