FDIC limits change for retirement plans.

Final regulations under the Federal Deposit Insurance Corporation (FDIC) Improvement Act of 1991 were published on May 25, 1993. The rules described in these regulations may have some surprising consequences for retirement plans that invest in savings instruments of regulated financial entities.

In general, under prior law, retirement plan assets were provided with FDIC coverage, limited to $100,000 per plan participant. This legislation and the interpretations in the final regulations have made significant changes in those rules which may come as a surprise to many depositors and to some financial institutions.

"Passthrough" deposit insurance coverage

The general rule remains that insurance coverage is set at $100,000 per plan participant provided that the FDIC's record-keeping requirements are satisfied. For this purpose, "plan" includes qualified retirement plans under Sec. 401(a), including plans that cover owner-employees under Sec. 401(d); plans defined in Sec. 457; and funded welfare plans.

The inclusion of Sec. 457 plans for full "passthrough" insurance was established by the legislation. Previously, the Federal Savings and Loan Insurance Corporation (FSLIC) had provided coverage for these programs on a per participant basis, but the FDIC had only insured them on a per plan basis.

The eligibility of welfare plans for passthrough coverage is also new. However, to be insured on a per participant basis, the participant's interest must be ascertainable and not contingent. Thus, many welfare plans will not be able to obtain per participant coverage since there is no individual accounting performed.

The primary change in this area is the elimination of "passthrough" coverage for deposits in institutions not "adequately capitalized." When this rule appeared in the statute, two questions immediately arose: What is the definition of "adequately capitalized"? How is the investor to get this information? Happily, the regulations respond to both questions.

First, "adequately capitalized" will generally mean that the institution is allowed to accept brokered accounts. Institutions that have not yet gained FDIC approval to offer brokered accounts, but are "adequately capitalized," can qualify for "passthrough" coverage. The rules are set by the institution's controlling organization; this may be the Comptroller of the Currency, the Office of Thrift Supervision or the Board of Governors of the Federal Reserve System. Institutions that are "adequately capitalized," but have not yet received clearance to offer brokered accounts, must provide a written statement to the fiduciary noting that "passthrough" coverage is applicable.

The preamble to the regulations specifically notes that it is acceptable for a plan fiduciary to request this information of the financial statements and that it can be provided without violating the limitation on advertising capital ratios. To the extent that the fiduciary wishes to independently verify this information, the preamble also lists three sources of information. The most current source would be Call Reports, which are updated quarterly and are available from the FDIC at a cost of $2.50 each. Other sources are the Uniform Bank Performance Reports or state reports from the Federal Financial Institutions Examination Council. In addition, private rating services provide this information for a fee.

To obtain "passthrough" status, the financial institution must meet these conditions at the time the deposit is accepted. To the extent that the financial condition of an institution deteriorates after the deposit is accepted, the "passthrough" coverage with respect to that deposit is not jeopardized; it is set at the time of deposit. However, "deposit" is interpreted very literally. Thus, for example, a rollover or renewal of an existing certificate would be considered a new deposit, and the condition of the institution would need to be verified on the renewal date. The plan fiduciary does not need to constantly monitor a financial institution's status. Instead, the status simply needs to be verified at the time of deposit. Further, the status of the institution can be based on the most recent data available. For example, the Call Report for the prior quarter would be acceptable unless "(1) [t]here is an intervening Report of Examination which causes the institution to be placed in a different capital category; or (2) a major event occurs which causes the institution to be in a different capital category, the institution sends its primary federal regulator a notice thereof, and the primary regulator sends a notice back to the institution confirming that the institution's capital category has changed; or (3) the institution receives written notice from its primary federal regulator that it has been reclassified." In other words, the fiduciary needs to use the Call Report and confirm the numbers with the institution.

Second, all covered financial institutions must issue a notice to depositors by Oct. 10, 1993 regarding these changes.

Aggregation of plans

Under prior rules, an employee's noncontingent interests in each benefit plan by the same employer were aggregated for purposes of the "passthrough" limits. This has not changed. However, some new rules result in the aggregation of interests in plans not previously aggregated.

Under the new standards, balances in individual retirement accounts (IRAS) must be aggregated with any Sec. 457 balances and with the employee's noncontingent interest in self-directed accounts under employee benefit plans. This includes plans described in Sec. 401(d) and plans described in Section 3(34) of the Employee Retirement Income Security Act of 1974 (ERISA). This is a narrower definition than that used in the section, "Passthrough" deposit insurance "coverage," as it only covers defined contribution deferred compensation plans.

The concept of "self-directed" for this purpose is very narrowly defined. it includes only programs in which the participants have the right to direct some portion of their account into a financial institution's deposit account. Thus, directing participants into a fixed income fund that includes deposit accounts of the institution, but over which they do not have an authority to select underlying investments, would not be considered self-directed. Further, the fact that a specific plan participant can choose the institution in which the investment is made-because that individual is both a participant and the named fiduciary-does not create a "self-directed" account. In that case, the choice would be made in the role of fiduciary, not as a participant.

When there is a truly "self-directed" plan, the balance of any IRA held within the particular financial institution of a participant in that plan must be combined with any directed investment in determining the insured amount.

Although it is fairly rare to see this degree of self-direction within a qualified retirement plan, it is not nonexistent with respect to smaller plans. Also, remember that Sec. 457 plan balances are aggregated whether or not they are subject to self-direction.

Vesting 

The final regulations effectively modify the rule regarding the aggregation of plans for purposes of the insurance limits; only the vested interest in a participant's account is recognized. This rule does not apply with respect to the general rule covering "passthrough" coverage on employee benefit plans. Rather, it is limited to the special aggregation rule for IRAS, Sec. 457 plans and "self-directed" plans. This represents a dramatic change from the proposed regulations, which had suggested that the insurance coverage be limited to the vested percentage under all circumstances.

BICs and similar instruments

This is the area of change that has received the least publicity, but may be the most important as it is the most unexpected.

Previously, bank investment contracts (BICS) and similar instruments were eligible for the normal "passthrough" coverage rules. However, currently, FDIC coverage is specifically denied to "benefit responsive" contracts. If a contract is "benefit responsive," the plan does not receive "passthrough" or any other coverage with respect to that investment.

A contract is "benefit responsive" if the ordinary withdrawal penalties that would have been imposed by the institution (not the IRS) are waived with respect to normal plan distributions on intraplan transfers.

This rule is applied to the broad definition of a plan found in ERISA Section 3(3). This means that welfare plans, for example, are included. There is some controversy as to whether or not Sec. 457 plans are covered. The legislative history to the 1991 law implies that Sec. 45 7 plans are not subject to the BIC restrictions. However, the legislative history specifically refers to Sec. 457 plans that are not ERISA plans; it does not address Sec. 457 plans subject to ERISA. In light of this controversy, the final regulations have chosen to exclude Sec. 457 plans from this restriction on coverage.

Notice requirements

The proposed regulations on these changes suggested that all affected institutions notify all customers of the changes in coverage. Apparently, this proposal brought more comment than any other aspect of the regulations. The concern was that the notice would needlessly alarm customers who were not affected by the change and that it would be expensive to distribute.

In response, the final regulations allow the financial institution to choose whether to notify all customers or only those it considers to be potentially affected by the rules. Further, the financial institution is granted a great deal of flexibility in deciding how to give notice. That is, it can be part of a separate mailing, included on the face of a normal statement of account, etc. However, no flexibility is authorized with respect to the notice's contents.

The proposed notice must be issued by Oct. 10, 1993, and must read as outlined below with no changes:

In December, 1993, some of the FDIC'S deposit insurance rules will change. The rule changes will primarily affect the total amount of coverage which is provided for IRA, self-directed Keogh plan accounts, self-directed defined contribution plan accounts, "457 Plan" accounts and accounts where an insured institution is acting in a fiduciary capacity. If you do not have these types of accounts, those rule changes will not affect you. For further information, contact [insert "your branch office" or some other contact point for the institution].

Significantly absent from this notice is any indication of the new rules with respect to BICs. Presumably those changes are outlined in the BIC instrument.

Effective dates

The changes on passthrough coverage for institutions that were not "adequately capitalized" were effective on Dec. 19, 1992. The changes with respect to BICs and the aggregation of IRAs and self directed accounts become effective on Dec. 19, 1993. There is a grandfather provision for time deposits made before Dec. 19, 1991; these do not become subject to the new rules until the first maturity date after Dec. 19, 1993. From Becky Miller, CPA, Rochester, Minn., and Toby Cohen, CPA, Pinehurst, N.C.