Take-Away: Federal Deposit Insurance (FDIC) insurance coverage for deposit accounts held by a trust depend on the number of identifiable, primary,  trust beneficiaries. The rule is also changing in 2024.

Background: With a couple of bank failures in the news the past few months, our thoughts immediately turn to insurance provided by the Federal Deposit Insurance Commission (FDIC) and the protection that it provides to the owners of deposit accounts. For a personal account, the FDIC coverage insures up to $250,000. However, the amount of coverage for a trust is a bit more complicated.

Revocable Trusts: A revocable trust financial deposit account is considered to be a testamentary deposit account. This means that on the settlor’s death the funds held in the settlor’s trust then pass to one or more identified beneficiaries. The FDIC recognizes two types of revocable trusts: (i) an informal trust, in some jurisdictions informally called a Totten trust; and (ii) a formal, inter vivos, or living, trust.  The FDIC applies the same set of regulations to calculate the insurance covered for either of these two types of revocable trusts.

Conditions: The FDIC insures a revocable trust only so long as the trust meets three requirements. First, the title of the trust must reflect a testamentary intent. Second, the trust instrument must reflect the specific names of the primary trust beneficiaries. Third, the trust beneficiaries must be eligible, which means that they must be either a person or an IRS-recognized charitable organization or non-profit entity.

Insurance Coverage: Each owner of the revocable trust account is insured up to $250,000 for each eligible, primary, beneficiary. Thus, the exact amount of the insurance coverage will depend on the number of primary, eligible beneficiaries. The FDIC coverage amount of a trust-owned account with five or less trust beneficiaries is determined by multiplying the number of owners of the account by the number of beneficiaries by $250,000.

Example: Steve creates a revocable trust which becomes irrevocable on Steve’s death. Steve’s three sons, Tim, Chip, and Ernie are the named beneficiaries of Steve’s trust. Consequently,  the maximum amount of the FDIC insurance for the deposit account held in Steve’s revocable trust is $750,000. [1 (Steve) x 3 (Tim, Chip and Ernie) x $250,000 = $750,000.]

Limitations: When the number of primary, eligible, trust beneficiaries is greater than five, FDIC insurance coverage can exceed $1,250,000, but that calculation is much more complicated. In this instance, the insurance coverage of the FDIC is allocated to each of the eligible beneficiaries according to the trust instrument, but it then triggers an insurance limit to each beneficiary’s interest in the trust.

Irrevocable Trust: An irrevocable trust account is a deposit account that is held in the name of an irrevocable trust. Settlors of the irrevocable trust are called ‘grantor’s’ under the FDIC rules. While grantors contribute funds or property to the irrevocable trust, the obvious feature of the irrevocable trust is that the grantor cannot amend or revoke the trust instrument.

Conditions: The FDIC insures ab irrevocable trust’s deposit accounts that are valid under state law, titled in the name of the trust, that discloses the identities and interests of the trust beneficiaries in the trust instrument.

Insurance Coverage: Irrevocable trust accounts that meet the requirements are insured up to $250,000 for the non-contingent trust interest of each trust beneficiary.

Example: Steve, the grantor, created an irrevocable trust for the benefit of his three sons, Tim, Chip and Ernie. Each of the sons has a non-contingent interest, e.g. each son is to receive his share of the trust corpus upon Steve’s death. Thus, the FDIC coverage for this irrevocable trust is $750,000.

Non-Contingent Interest: In order for an interest in an irrevocable trust to be non-contingent, the interest must not be conditioned on some other event or subject to divestment.

Example: Steve’s irrevocable trust for his three sons provides that his son will not receive a distribution from the trust until that son graduates from college. The condition of graduating from college would be conditioned on some other interest.

Example: Steve’s irrevocable trust for his sons gives the trustee the discretion to make distributions among Steve’s three sons, e.g. a ‘pot trust’ is created. While the sons’ contingent interests are still FDIC insured, the maximum FDIC insurance amount available to Steve’s irrevocable trust is only up to the $250,000 amount in the aggregate.

New FDIC Rule: In January, 2022 the FDIC approved a change to its deposit insurance coverage rules for revocable trust accounts, including payable on death (POD) arrangements, irrevocable trust accounts, and mortgage servicing accounts. This new rule becomes effective on April 1, 2024. For most trust depositors (those with less than $1,250,000) the FDIC expects the coverage levels will be unchanged. However, the new rule may reduce coverage for those depositors who have placed more than $1,250,000 per owner in trust deposit accounts at one insured institution.

Combined Categories: The new FDIC deposit insurance rule combines the former revocable and irrevocable trust account categories into one, single, insurance coverage category. The combined category is simply called trust accounts. Under this new trust accounts category, each trust owner has coverage up to $250,000 per eligible primary beneficiary, up to a maximum of five beneficiaries. Again, to be an eligible beneficiary the primary  beneficiary must be a living person or an IRS-recognized charity or non-profit organization. Consequently, under the new trust accounts FDIC insurance coverage rules, the coverage calculation is the same calculation that the FDIC currently uses for a revocable trust with five or fewer beneficiaries. Each owner has coverage up to $250,000 per eligible primary beneficiary (up to five.)

Multiple Accounts: If an owner has multiple accounts at the same bank or financial institution, under the old rule, the owner calculates its FDIC coverage limits separately for each account. The FDIC combines the balances of the accounts under its new rule and calculates the coverage limit together.

Example: Steve owns a revocable trust with his three sons, Tim, Chip and Ernie as the primary eligible beneficiaries of the trust on Steve’s death. Steve also owns an irrevocable trust with two primary eligible beneficiaries, his grandchildren, at the same FDIC insured bank. Steve’s FDIC insurance coverage for the total of both accounts is up to $1,250,000. This is the result, regardless of which trust account holds the majority of that balance.

Conclusion: With the change in the FDIC insurance coverage rules for trusts scheduled to take effect on April 1, 2024, that should give both bankers and depositors time to adjust to the new rule, including time to make any changes to avoid the potential reduction in FDIC insurance coverage. Accordingly, depositors should review the new rules for time deposits with maturities beyond April 1, 2024.