With more banks expected to fail, it's a good time to look into the protections available for your retirement accounts

In the wake of the historic government bailout of Fannie Mae (FNM) and Freddie Mac (FRE), investors wonder which bank will fail next. Indeed, images of customers lined up last July outside offices of the failed IndyMac Bank to withdraw their money are hard to forget. The Federal Deposit Insurance Corp. (FDIC) recently reported that 117 banks, the highest number in five years, are on its "problem" list, and "more banks will come on the list as credit problems worsen."

It's no wonder that some Americans are asking themselves if the money they've accumulated in retirement accounts is adequately protected. "Clients are expressing concerns about whether their accounts are safe. This has occurred because of the demise of both IndyMac Bank and Bear Stearns and the major decline in most bank and financial stocks," says Kevin Reardon, a financial planner in Brookfield, Wis.

In general, the answer is that your retirement accounts are safe. Three key factors determine how well your money is protected: the type of account you have, where the account is located, and how much is in each account. Here's a rundown on the rules to help you determine if you need to make any changes in where and how you hold retirement savings in banks, brokerage accounts, and your 401(k).

Broader Insurance Coverage

At this point just about everyone knows your standard bank account is insured by the FDIC for up to $100,000. Less well known is that since 2006, a traditional or Roth IRA, a Simplified Employer Plan (SEP), and several other types of retirement accounts that you hold in an FDIC-insured bank are covered by insurance up to $250,000. The insurance applies to the retirement account in addition to insurance on your other accounts in the same bank. The FDIC does not release its list of problem banks, but it does offer a list of bank rating sources you can consult if you're concerned about a particular institution. If your FDIC-insured retirement account exceeds $250,000, or if you are worried about the bank's financial health, you can move some or all of the asset to another institution. But just make sure you follow the rules for a trustee-to-trustee transfer so you don't get hit with taxes or penalties on a withdrawal.

Retirement accounts housed at a brokerage receive the same protection as other types of brokerage accounts if the firm belongs to the Securities Investor Protection Corporation, an organization funded by securities broker-dealers. SIPC is charged with returning "customers' cash, stock and other securities" in the event a company fails or customer assets are missing. But SIPC rules differ from those of the FDIC, and some types of investments, such as commodities contracts, are not insured by SIPC.

It's common to hear that these accounts are insured up to $500,000, but SIPC President Steve Harbeck says that's not the whole story. If a brokerage closes, "the real protection comes from the fact that each customer gets a pro-rated share of all the customer property that is intact," plus insurance up to the $500,000 limit, Harbeck explains. Consider a customer with two accounts—a SEP and a regular brokerage account—in a firm that closes. Each account contains $5 million in securities. The company has 50% of "customer property"— or $2.5 million in each case—available to distribute to each account. Above that level, SIPC would provide an additional $500,000 in securities to each account, so the owner would end up with $3 million for each account.

In addition to SIPC, you may have more insurance if your account has "excess SIPC" insurance offered by CAPCO, an insurance company created in 2003 for this purpose.

Recalling Enron

The Employee Benefits Research Institute (EBRI), a Washington nonprofit group, reports that about half of the nearly $7 trillion in American retirement accounts in 2004 was in 401(k)s or similar employee-sponsored accounts. You may remember that when Enron collapsed, employees lost enormous amounts of money in their retirement accounts, mainly because they had invested in company stock. There is no law that can protect your 401(k) from losing money because of bad investment decisions.

However, the Employee Retirement Income Security Act does protect your 401(k) or similar employer-sponsored retirement account by requiring the money to be placed in a trust or in an insurance contract, where it is separated from the company's own operating funds. The law also holds fiduciaries and trustees who make decisions on managing your employer's plan responsible for investing and managing the plan for the benefit of participants and their beneficiaries.

In a worst-case scenario, a company might go bankrupt, fail to make the required contributions to the retirement plan, or take inappropriate investment risks that jeopardize the health of the plan. If any of these things happen in your company, and if the employer, a fiduciary, or a trustee of your retirement plan breaks the law, a court may order that the missing funds be put back into the plan. The U.S. Labor Dept. reports that in 2005 (the latest available data), such court action led to restoration of more than $700 million in plan assets and benefits. But a Labor Dept. spokesperson could not say what proportion of all such court-ordered restorations are actually carried out.

Finally, if you have a traditional (defined-benefit) pension plan, please see my column, What the new Pension Law Means to You (7/1/06), about the protections afforded by the Pension Benefits Guaranty Corp.

You've probably scrimped and saved and even made personal sacrifices to keep contributing to your retirement accounts. The percentage of accounts at risk is probably tiny. But there's a reason that the government and various industry groups have set up this complex system of protections. To make sure that your savings for the future really are secure, it's worth reviewing the status of coverage for your accounts or ask your financial adviser to do so.

Business Exchange related topics:Retirement StrategiesCorporate Pension CrisisBaby Boomer RetirementGay and Lesbian RetirementRecession-Proofing Your Job