Bank Products

Florida FINRA Fraud and Misrepresentation Arbitration and Litigation Attorney Russell L. Forkey, Esq.

September, 2011:

Even in dealing with a  bank, it is important that a potential investor completely understand the terms and risks associated with the product that is being considered.  The following post is designed to provide general information concerning these issues.  Please keep in mind that this information is not designed to be complete in all material respects.  Thus, this information should not be relied upon as legal or investment advice.  If you have any questions concerning the following information you should contact a qualified professional.

Bank Products:

For many people, the first financial institution they deal with, and the one they use most often, is a bank or credit union. That's because banks and credit unions provide a safe and convenient way to pay your bills and accumulate savings, as well as other services that can help you to manage your money.

Banks offer two main products:

  1. Transaction accounts, better known as checking accounts, which allow you to transfer money by check or electronic payment to a person or organization that you designate as payee; and
  2. Deposit accounts, which include savings accounts and money market accounts, which pay interest on your money in those accounts.

Deposit accounts are a good place for funds that you want to be safe, liquid and easy to get to-such as savings for a down payment, or a cushion for unexpected expenses like car repairs or emergency medical expenses. And if you're setting aside money for future financial goals with a known deadline, you can consider another type of savings product called a certificate of deposit (CD). 

Federal Insurance:

The money you put in a bank account is insured by the Federal Deposit Insurance Corporation (FDIC), an independent agency of the U.S. government. There's comparable protection for credit union deposits from the National Credit Union Share Insurance Fund. With this protection, your deposits are secure up to the maximum coverage that Congress has approved, even if your bank or credit union goes out of business. This coverage applies separately to each bank where you have accounts.

The exact amount of insurance at each bank depends on two factors-the kinds of accounts you have and the way those accounts are registered:

  • Single accounts: Your total deposits in all the checking and savings accounts you own solely in your own name are currently insured up to $250,000. This limit might change at the end of 2009.
  • Joint accounts: Your total share of all the checking and savings accounts you own jointly with others is currently insured up to $250,000. This limit might change at the end of 2009.
  • Self-directed retirement accounts (such as IRAs): The balances in your self-directed retirement accounts are insured up to $250,000, provided that the money is in certificates of deposit or other bank accounts.
  • Revocable trust accounts (including payable-on-death accounts and living trust accounts): Each account that names a different beneficiary is insured up to $250,000.

Let's assume, for example, that you had the following accounts at one bank:

  • $5,000 in a checking account plus $245,000 in various savings accounts held in your name
  • $200,000 in a savings account that you own jointly with another person
  • $250,000 in certificates of deposit in an IRA
  • $200,000 in two payable-on-death account with different beneficiaries

According to the FDIC insurance rules, all of those deposits would be insured fully by the FDIC since each account is within limits of the coverage. In the case of the joint savings account, the insurance coverage would be shared by your co-owner, with each of you being eligible for $250,000 insurance.

Suppose, however that the only money you had in a particular bank was a certificate of deposit valued at $300,000, and you were the sole owner. In that case, $250,000 of that amount would be covered, and $50,000 would be uninsured. 

What FDIC Insurance Doesn't Cover:

In contrast to these bank products, securities investments such as stock, bonds, and the mutual funds that invest in them are not insured or guaranteed by the FDIC. They could lose value even if you hold them in an account, such as an IRA, that you open with your bank. That's true even if the bank's name is used in the name of investment, such as Bank X Growth Stock Fund. Insurance company products that a bank sells, including life insurance and annuities, aren't covered by the FDIC either. 

Basic Savings:

Bank savings accounts have traditionally been one of the simplest and most convenient ways to save. These accounts typically have the lowest minimum deposit requirements and the fewest withdrawal restrictions. But they often pay the lowest interest rates of any of the savings alternatives. However, when banks are competing for your deposits, they may offer substantially higher interest or other benefits for opening a savings account.

Traditional savings accounts used to be called passbook savings accounts, since tellers would record your deposits and add the interest you'd earned in a small booklet called your passbook. These days, electronic records make passbooks unnecessary. But some banks still offer old-fashioned passbook accounts, especially for children's savings accounts. 

Your Savings Account Interest Payments:

Most savings accounts pay compound interest, which means that your earnings are added to the balance to create a larger base on which future interest is paid. The bank will tell you whether the interest compounds daily, monthly, or on some other schedule, and when the interest is credited to your account. The more frequently it compounds, the faster your earnings will accumulate-though with small balances the increases won't be very dramatic. You generally begin to earn interest as soon as the money goes into your account, and that interest continues to accrue until you withdraw.

The bank will also tell you the basic interest rate and the annual percentage yield (APY). The APY is larger than the basic, or nominal, rate since it takes into account the impact of compounding. Banks often advertise the APY since it more accurately reflects the amount of interest the account will actually pay, and it makes the savings account a more attractive place to park your money.

Online banks may offer higher interest rates than more traditional brick-and-mortar banks. That's because online banks tend to have lower overhead, and can pass their reduced costs onto consumers in the form of increased earnings rates. Before deciding on a savings account, it pays to compare interest rates, along with other features, such as convenience of making deposits and withdrawals. Even a small difference in the rate can result in a substantial difference in interest over time, depending upon the amount you put into the account. 

Other Savings Account Features:

With a basic savings account, you can make as many deposits as you like, whenever you like. And you can usually withdraw as much as you like when you need the money. However, some banks may require minimum opening balances for basic savings accounts, and some banks charge fees if your balance falls below that minimum. Other banks don't have minimum balance requirements, so if your savings balance tends to be low, you may want to consider these fees in choosing a bank account.

You can also ask if the bank offers low-cost savings accounts. Many banks offer more flexible alternatives for children, college students, and senior citizens, and for people whose income falls below certain limits. But the way these accounts work vary from banks to bank.

One thing you can't do with a basic savings account is transfer money to another person or institution, so you can't pay bills from your savings account. But you can generally transfer funds from your savings to your checking account electronically, or withdraw funds from one of your savings account and deposit them in another. You should be aware of Federal Reserve Regulation D, though, which limits you to six transfers from your savings account in any four-week period, whether these transfers are made electronically, automatically, or by phone. 

Emergency Funds:

It's a good idea to have a separate savings account to serve as your emergency fund. Most experts agree that's important to set aside enough money to cover your living expenses for three to six months in an account you use exclusively for this purpose. This money would come in handy, for example, if you were to stop earning income temporarily, or if you were faced with unexpected events, such as big medical bills, or any other expense that could arise without warning. Without savings, you might need to rely on credit cards and other borrowing to pay for emergencies, which could result in serious debt. 

Money Market Accounts and Money Market Mutual Funds:

Money market accounts are similar to savings accounts, but may pay higher interest rates. However, they tend to have higher balance requirements than savings accounts, and different interest rates may apply to different account balances. For example, there may be one rate for balances below $10,000, a higher rate for balances between $10,000 and $25,000, and an even higher rate for $25,000 and above. In addition, you may need a larger deposit to open a money market account.

Unlike traditional savings accounts, money market accounts let you write a limited number of checks each month, in essence combining features of savings and checking accounts. The ceiling is usually three checks-another of the restrictions imposed by Federal Reserve Regulation D. If you exceed the limit, the bank won't process any new transactions until the next period. However, you can make all the withdrawals you want by visiting a bank branch office in person, and you can deposit that money into your checking account without penalty.

You may want to use a money market account for a portion your emergency fund, or to park money you intend to invest until you've accumulated enough to make a particular purchase.

Money market mutual funds are similar to money market accounts in some ways. They typically pay interest at about the same rate and many offer check-writing privileges. One advantage is that there's usually no limit on the number of checks you can write each month. However, any check you write against the account may have to be for at least the required minimum, such as $500. One drawback is that money market funds, unlike money market accounts, are not FDIC insured, although some offer their own insurance. While fund companies try to keep their money market share price stable at $1 a share, there is the possibility you could lose some of your principal. 

Certificates of Deposit (CDs):

Certificates of deposit (CDs) are time deposits. When you choose a CD, the bank accepts your deposit for a fixed term-usually a preset period from six months to five years-and pays you interest until maturity. At the end of the term you can cash in your CD for the principal plus the interest you've earned, or roll your account balance over to a new CD. But you must tell the bank what you've decided before the CD matures. Otherwise the bank may automatically roll over your CD to a new CD with the same term at the current interest rate. And you might earn a better interest rate with a CD that has a different term, or one offered by a different bank.

CDs are less liquid than savings accounts. You can't add to or withdraw from them during the term. Instead, to buy a CD, you need to deposit the full amount all at once. If you cash in your CD before it matures, you'll usually pay a penalty, typically forfeiting some of the interest you've earned. To make up for the inconvenience of tying up your money, CDs typically pay higher interest than savings or money market accounts at the same bank, with the highest rates for the longest terms-though there are exceptions to this pattern. Like other savings accounts, bank CDs are insured by the FDIC, with your CD account balances counting toward your total insured amount. 

CDs for Different Interest Rate Environments:

In the past, each CD paid a fixed rate of interest over its term. But today you can also find variable rate CDs, sometimes called market rate CDs. With these accounts, the interest rate may rise and fall with changing market rates or be readjusted on a specific schedule. If the current rate is low, it may make sense to purchase a variable CD. That way, if interest rates rise, you won't miss out on the rate increase. On the other hand, if you expect rates to fall in the future, it may make more sense to buy a fixed-rate CD to lock in the higher rate for a specific term.

Another alternative is to create a CD ladder. You might start by dividing the amount you plan to invest in CDs into four equal amounts and buy four CDs with varying terms-say three months, six months, nine months, and one year. As each CD matures, you replace it with a one-year CD, so you have an amount to cash in or reinvest on a regular schedule. If you used a longer ladder, so that your CDs matured on an annual instead of a quarterly basis, you would never have all your money invested at the same rate, which would allow you to avoid locking in a large sum at a low rate.  

Take Care With Long-Term CDs and Call Features:

CDs are usually described, quite accurately, as conservative investments because of their FDIC insurance and relatively short terms. However, not all CDs are alike. In addition to regular CDs, whose terms are rarely longer than five years, banks may offer long-term, high-yield CDs that pay a much higher rate of interest for terms as long as 10 or 20 years. These CDs may be callable, which means that the bank has the right to terminate the CD and pay you back your principal plus the interest earned to that point. This usually happens if your CD is paying higher interest than CDs currently on the market, and it means you would have to reinvest your principal at a lower rate than your old one paid. However, unlike the bank, you don't have the right to end a CD contract if the situation is reversed and your CD is paying less than the current market rates.

In fact, you may want to think twice about any long-term CD because of the early withdrawal penalty. Generally speaking, investments that cost you money simply for changing your mind are rarely the best alternative. 

Brokered CDs-Not Always FDIC Insured:

You may also be offered a brokered CD by a stockbroker or other investment professional who serves as a deposit broker for the issuing bank. Brokered CDs may have a longer holding period than a CD you purchase directly from a bank, and they may be more complex and carry more risk. Although most brokered CDs are bank products, some may be securities-and won't be FDIC insured.

Brokered CDs differ in other ways from traditional CDs. For example, you may have to pay a fee to buy a brokered CD, either as a fixed amount or as a percentage of the amount you are investing. If the fee is modest and the CD is paying a higher rate than you could find on your own, you may come out ahead. But you should take the fee into account. You may also have to invest a minimum amount, such as $10,000 or more.

If the bank issuing the CD is FDIC-insured and if the CD is a bank product, your account value should be insured for up to $250,000. (This limit might change at the end of 2009.) Keep these two things in mind, though: To be eligible for insurance, you must be listed as the CD's owner, so you'll want to confirm that it's registered to you or held in your name by a custodian or trustee. Second, if the issuer happens to be a bank where you already have money on deposit, the total value of your accounts could be higher than the amount of the insurance. If the bank fails, you might be vulnerable to loss.

Unlike a traditional CD, brokered CDs can't simply be cashed in with the issuing bank. As a result, some firms that offer brokered CDs may maintain a secondary market-but these secondary markets tend to be quite limited. If you want or need to liquidate your brokered CD before maturity, you may be subject to what's known as market risk. This means the CD may be worth less than the amount you invested because other investors are not willing to pay full price to own it. This might happen if the interest rate that new CDs are paying is higher than the rate on your CD. 

Questions to Ask About CDs

Before you buy any CD, you should ask several questions:

  • What interest rate does the CD pay and what is the annual percentage yield (APY)?
  • Is the rate fixed or variable, and if it's variable, what triggers an adjustment and when does the change occur?
  • When does the CD mature?
  • What's the penalty for early withdrawal and are there exceptions to the early withdrawal fee?
  • Does the bank have the right to call the CD, and if so, when could that occur?
  • Is the issuing bank FDIC insured?

And if you purchase a brokered CD through a deposit broker, you should also ask the following additional questions:

  • Is the brokered CD a bank product or a security?
  • What is the name of the issuing bank?
  • Is the issuing bank insured by the FDIC?
  • Is the deposit broker someone you know-whose credentials you have checked?

CDs are useful additions to most investment portfolios because they offer safety and a predictable return. If you keep a portion of your assets in cash, CDs or U.S. Treasury bills are usually the most logical choices. And if you've been accumulating money to pay for specific goals, such as making the down payment on a home or paying tuition bills, you may want move some of this money into CDs as the date you'll need the money gets closer. That way, you can be sure you'll have it when you need it.

Beyond Banking:

In addition to checking and savings accounts, your local bank may offer you investment accounts that you can use to save for college or retirement, insurance coverage for your home or your life, or annuities to help you generate retirement income. But it's important to remember that just because you're buying these products from a bank doesn't mean they're FDIC insured. In fact, they're not.

However, you may find that the convenience of having all of your financial activities under one roof makes your life easier. And if you already have a relationship with a particular bank, you may feel more comfortable going there for a broader range of financial services. In fact, some banks now employ investment professionals, as well as tellers and account managers to help you coordinate your whole financial strategy. If you are unsure about which accounts are insured and for how much, be sure to ask.