Monday, March 13, 2023

Brokerage accounts and SIPC Limits

Plenty of ink has been spilled over FDIC Insurance Limits this weekend being only $250,000.

But as an equity investor, are you aware that you are protected from Broker failure under SIPC for only $500,000 per separate account per brokerage?

SIPC stands for Security Investor Protection Corporation. It protects investors against the loss of securities and cash held at SIPC member brokerage firms.

If your broker fails, that shouldn't necessarily affect client investments. That's because client assets are segregated from the assets of the brokerage house. In that case, the SIPC may step in and help with the transfer of assets over to a new brokerage firm. In other words, investors would simply be able to access their investments at another brokerage house, if their original broker failed.

However, in the case of fraud or commingling of customer and brokerage assets, SIPC insurance can come in handy. SIPC gets involved in this case and provide the protection for customer assets.

It protects investor securities up to $500,000 per account per brokerage. Examples of securities include stocks like PepsiCo or bonds like US Treasury Bills for example. 

The protection for cash held in a brokerage account is only $250,000 however. This is in line with the FDIC protection limits.

SIPC protects the custody function of the broker. This means that the SIPC would restore missing stocks or bonds after a broker fails or is liquidated. In other words, if you have 100 shares in PepsiCo held at a brokerage firm that fails, you will receive 100 shares of PepsiCo back.

SIPC does not offer protection against decline in the value of your stocks or bonds and losses from selling stocks and bonds.  Just be aware that the SIPC is not created to insure against risk in quotational losses on investments.

The neat thing is that SIPC protection limit of $500,000 is per each separate account type. 

For example, if you have a brokerage account worth $500,000 and a Roth IRA worth $500,000 at the same broker, your entire amounts are protected by SIPC against the loss of securities due to brokerage failure. That's because the taxable account and the Roth IRA account are considered to be of separate capacity by the SIPC. 

However, if you happen to have two taxable brokerage accounts with $500,000 each, your total protection by the SIPC is a total of $500,000. That's because accounts held in the same capacity are combined for purposes of the SIPC protection limits. In other words, the same types of accounts are combined and subject to the $500,000 protection limit.

Examples of separate capacities are:

  • individual account;
  • joint account;
  • an account for a corporation;
  • an account for a trust created under state law;
  • an individual retirement account;
  • a Roth individual retirement account;
  • an account held by an executor for an estate; and
  • an account held by a guardian for a ward or minor.

My opinion:

In my opinion, it is helpful to be aware of the SIPC insurance limits. It is helpful to invest through a legitimate stock broker, who is a member of SIPC. 

In my opinion, it may be helpful to hold more than one brokerage account and more than one broker. That's merely some diversification in case one broker fails. In the event that this happens, it may take some time to access those accounts and the assets in them. That could disrupt even a meticulously planned fail safe retirement plan. 

In addition, it is helpful to hold more than one broker account because of potential outages as well. 

Several readers have indicated how many brokerages have additional insurance above the SIPC limits. I do not believe this is as good as an implied government backstop that SIPC coverage provides. 

I believe that in a crisis the US Government would step in as it has unlimited resources in theory. Any excess brokerage insurance through a private insurance company may not be realizable. In other words, if too many customers need to use those policies, the insurance company may not be able to pay them off at once. It may end up going bankrupt. 

Of course, needing SIPC insurance is a low probability event in the first place. Needing to collect on an insurance policy in excess of SIPC insurance is an even lower probability event too. That would require an Armageddon type event that would have a brokerage fail and fail to segregate customer assets properly. Of course, while the probabilities are very low, they are not non-existent.

I am not trying to scare anyone; these are just a few random thoughts I had after looking through the headlines over the past weekend and the bank failures.

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