Motley Fool Answers’ September Mailbag: How Important Is SIPC Insurance?

Ah, the traditional pleasures of September. Summer's heat starts to recede. Pumpkin spice–flavored everything starts to appear on menus. People get in their first complaints of the year at seeing retailers roll out the Christmas marketing before they've even picked out their Halloween costumes. And, of course, here at Fool HQ, the month would not be complete without a mailbag show from Motley Fool Answers podcast hosts Alison Southwick and Robert Brokamp. To help them address all your autumnal financial conundrums, Sean Gates, a financial planner with Motley Fool Wealth Management (a sister company of The Motley Fool), returns to the studio. 

In this segment, they dig into an obscure facet of the investing world: SIPC insurance. The system is similar to the FDIC insurance that ensures you'll get your money even if your bank fails, but in this case, it guarantees your assets up to a certain level if your brokerage folds. So: Should one spread one's money around to avoid going over the program's per-account cap?

A full transcript follows the video.

This video was recorded on Sept 25, 2018.

Alison Southwick: The next question comes from Jodi. "I have two accounts that are pushing the boundaries of the SIPC coverage; a brokerage account at Ameritrade, thanks to great investment advice from Stock Advisor, and a 401(k) at Fidelity. I also have a much smaller investor account at Fidelity. Are there any recommendations on what to do if you pass the SIPC coverage limit? Do most full accounts at one brokerage each have their own SIPC coverage? Also, how do you go about splitting a 401(k) account in two? Can you just transfer holdings to another 401(k)?"

Sean Gates: Yes. SIPC insurance is an insurance that is conceptually similar to the FDIC insurance, which enforces banks. If you have money at a bank or savings institution, you can have protection if that underlying institution were to go bankrupt, or if there was a run on the banks, you would be reimbursed. In this case the FDIC is sort of a federal program that you can rely on.

SIPC insurance isn't really backed by the government. It's a form of reinsurance that all of the different financial institutions pay into. They pay dues into it to support the program. It's also not protection on the value of your account if it went down just because the stock market went down. If Fidelity went bankrupt and in the proceedings of that bankruptcy were not able to give you the value of your shares back, then the SIPC insurance would work to make sure that you have renumeration for those shares.

So a little bit complicated, but as you get into the specifics of it, what's interesting is different than FDIC insurance, SIPC insurance is coverage levels at what they refer to as capacities. Typically, a decent analogy to think about it is the account type. So if you have a corporate account that has $500,000 worth of SIPC insurance, or if you have just a normal traditional IRA, that also has $500,000 of SIPC insurance. If you have a Roth IRA in addition to those two accounts, that has an additional $500,000 in SIPC insurance.

Then, you can also start to look at it if you have a joint account. That has its own $500,000. And then if you add an individual account, that has its own $500,000. In addition, you can also have $500,000 worth of SIPC insurance per the brokerage firm. So if you have a joint account at Fidelity, that has its $500,000. If you have a joint account at Charles Schwab, that has $500,000.

Long story short, SIPC insurance is something that people ask about because they want to make sure they're protected. The reality of needing to utilize SIPC insurance is quite low. I think there might be maybe a total of five claims against SIPC insurance, or some astronomically small amount. Also keep in mind, just further nerding out on this question, that most brokerage firms, because it's mostly supported by the brokerage firms, purchase excess SIPC insurance so they will basically get an additional layer. Now, it's not a ton. It might be another $150,000 worth of insurance per account, or something to that effect.

And the excess SIPC insurance, according to the records and the forensic analysis, has only been utilized twice in history, and these programs are only about 43 years old, give or take, so they're a relatively new program, but I think I would assuage any concerns that you have. It's just very unlikely that these firms go bankrupt and you have to worry about that.

Southwick: And what about part two? Splitting a 401(k) account in two?

Robert Brokamp: That depends. First of all, if you're talking about the 401(k) account you have with a current employer, they will have their own rules about whether you can move the money. If it's a 401(k) with an old employer, you can transfer it to an IRA. You can split it up into multiple IRAs if you want. That's really the big difference, there.