Better Rules for Living Trusts

January 25, 2012

Smart financial and estate planning requires taking into account various unforeseen events. Protecting your savings in the case of a bank or credit union failure is one important consideration.

Fortunately, the rules involving federal insurance provided by government agencies have changed, including those involving depositors with living trusts, a popular estate planning tool. Federal Deposit Insurance Corporation (FDIC) changed the insurance rules to benefit depositors with living trusts, a popular estate planning tool.
Old and new rules: Before 2005, federal insurance covered living trusts for up to $100,000 per account at a single financial institution in the event of a failure. Today, the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA) provides insurance coverage of up to $250,000 for each qualified beneficiary entitled to the trust's assets upon the death of the account owner.

So a living trust owned by one person with three children as beneficiaries is eligible for $750,000 in coverage.
(Note: Thanks to the passage of the Emergency Economic Stabilization Act of 2008, other financial institution accounts are also temporarily insured for up to $250,000, including those for checking and savings. After 2009, the federal insurance amount on these accounts, including checking and savings, is scheduled to go back to $100,000 but the insurance amount for living trusts will remain at $250,000.)

Before 2005, one little-known living trust problem occurred when a  trust required beneficiaries to meet certain conditions, such as graduating from college or attaining a certain age. These common conditions, known as "defeating contingencies," resulted in the trust having only the deposit coverage for an individual owner.

Today, federal insurance is not limited if there are defeating contingencies in the trust agreement. This means, for example, that a living trust account owned by one person and listing three children as the beneficiaries would be eligible for $750,000 of FDIC insurance -- even if the trust document contains conditions on when the children can get the money.
Here are a few points to keep in mind:

Only some living trust beneficiaries qualify. The beneficiary must be the account owner's spouse, child, adopted child, stepchild, grandchild, sibling, parent or stepparent. In-laws, cousins, nieces and nephews, friends, and charitable organizations do not qualify.
Living trust beneficiaries must become entitled to their interest in the trust when the owner dies. FDIC and NCUA coverage is based on the beneficiaries who meet this requirement at the time the bank fails. 

For example, let's say your living trust names your three children as beneficiaries but states that each child's share will pass to their children if the child dies before you do. Assuming all three children are alive at the time the bank fails, only the children -- not the grandchildren -- would be beneficiaries for insurance purposes. (That's because the grandchildren are not entitled to any trust assets while their parents are alive.) Coverage up to $750,000 ($250,000 per beneficiary) would be available on the trust's deposit accounts.

The account title at the bank must indicate that the account is held by a living trust. This rule can be met by using the terms "living trust" or "family trust" in the account title. 

Not all financial institutions and investments are insured. The FDIC and NCUA insure deposits in most, but not all, banks, savings associations and credit unions in the country. Foreign banks are not covered, although they may have some similar type of insurance.

Traditional bank accounts, such as checking, savings, trust and certificates of deposit, are insured through the FDIC and NCUA. 

However, securities, mutual funds, annuities and similar types of investments purchased through a financial institution are not covered by deposit insurance. Neither are the contents of a safe deposit box. Creditors (other than depositors) and shareholders of a failed institution are not protected by federal insurance. Treasury securities (bills, notes, and bonds) purchased by an insured institution on your behalf are also not insured but they are backed by the full faith and credit of the United States Government. In the event an institution fails, there are still ways you can recoup your investment, through another institution, a Federal Reserve Bank or the Department of the Treasury.  

Basic Federal Insurance Protection Rules

When it comes to your savings, it's better to be safe than sorry. By staying within the boundaries established by federal insurance, your funds will be protected in the event a bank or credit union goes under.

For starters, the FDIC and NCUA now generally insure the first $250,000 of funds in an account, including principal and interest. Furthermore, the $250,000 limit is based on the type of ownership -- not the number or type of accounts. For example, if you and your spouse have a joint account at a bank, federal insurance covers the first $250,000 of funds for each spouse for total coverage of $500,000. Plus, you're still covered for up to $250,000 for an individual account at the same bank.

Of course, if one owner of a joint account should suddenly die, the remaining owner becomes an individual owner. In that case, the federal insurance coverage for the account drops to $250,000.

If you're affluent, you can spread the wealth around, since the $250,000 limit applies separately to each financial institution.  For instance, if you have a million dollars in cash, you can be fully protected by depositing $250,000 in each of four different banks. 
Caveat: Pay attention to bank consolidations -- if two of your banks merge, your total coverage will be reduced.

A living trust (sometimes called a family trust) is a formal revocable trust created while you're alive. As the owner or grantor, you specify who will receive the trust assets when you die. You keep control of the trust assets during your lifetime and can change the trust at any time. At your death, a "successor trustee" distributes the assets in the trust according to instructions.

One advantage: Upon death, assets held in a living trust bypass probate. That means the assets pass to your heirs without having to go through the probate process in the courts, which can be time-consuming and expensive. The successor trustee, who you named earlier, takes over without court oversight.

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