Deposit Insurance Cap Includes Interest

QUESTION: Please clarify the limits on the insurance coverage at banks and savings and loan institutions. I have several accounts at different institutions, and all are less than $100,000. But what happens when compounding interest is added to the accounts and the amount then exceeds $100,000? I have also been told that if I maintain the accounts with different family members, my total insurance coverage increases beyond $100,000. I’m sure that with the unsettled condition surrounding the thrift industry these days, many must share my confusion.--R. D. M.

ANSWER: You are right, no doubt, about the confusion. Be advised that the rules governing deposit insurance are complicated, so you still might want to consult your branch manager for additional advice. But, in a nutshell, if interest accumulation puts your account over the $100,000 threshold, the amount over $100,000 is not covered by insurance. For this reason, experts say, many depositors buy certificates for $90,000 to $93,000, leaving them some margin for accumulating interest.

However, there is still more to say about deposit insurance.

Basically, one of the biggest misunderstandings about this insurance, for both banks and savings and loans, is that the $100,000 limit is applied solely on a per-account basis. Actually, the insurance coverage is based on a somewhat complicated set of categories of savings accounts, and savers are limited to $100,000 in insurance per category of savings per institution.

For the average saver, there are two categories of accounts: individual and joint. The Federal Deposit Insurance Corp. will insure both up to a maximum of $100,000 per person. But here’s the deal: If, for example, you maintain--as an individual--a $5,000 checking account, a $25,000 savings account and a $75,000 certificate of deposit, you have exceeded your insurance limit by $5,000, plus any accrued interest. The lesson? If you have several accounts at the same institution, be sure to check in whose names the accounts are held. If they are all in the same individual’s name and the total exceeds $100,000, you probably don’t have the insurance coverage you thought you did.

The rules for joint accounts are even more complicated, but the bottom line is that no single individual can qualify for more than $100,000 in insurance for accounts held jointly with others at a particular institution. For example, if you hold a $100,000 certificate with your spouse and two additional $100,000 accounts with your children, you are deemed to hold half of $300,000 worth of joint accounts, or a total of $150,000. That puts you $50,000 over the limit.

Savings Plan Sounds Better Than It Pays

Q: In planning for my 2-year-old’s eventual college education, I’ve come up with a strategy that seems to maximize tax deductions and tax-deferred income. I plan to take out a second mortgage on my home and put the proceeds into an annuity. This way I get a current tax deduction on the mortgage interest and tax-deferred income on the annuity. Does this make sense?--B. B.

A: On paper, yes. But according to our experts, your plan isn’t as sound as it appears on paper, for two principal reasons: Interest rates on second mortgages are considerably higher than those paid on annuities, and state and federal governments charge penalties for early withdrawal of annuity funds.

Let’s explain. For starters, interest rates charged for second mortgages are running about 12%, while annuities are paying 8% to 9%. This spread of at least 3 percentage points does not include the fees and closing costs charged by second-mortgage lenders. Further, if you take a distribution from the annuity before you turn 59 1/2, you face penalties of 10% from the Internal Revenue Service and 2.5% from the state of California.

Even if you or your wife should turn 59 1/2 before your child needs money for college, our experts recommend that you look for another strategy to fund his or her education. One financial planner says your strategy would make sense if the interest rate on second mortgages was no more than 2 percentage points higher than what your investment would pay. But such a scenario, he notes, is highly unlikely. He says you would be better off investing your child’s college fund in a growth mutual fund, double tax-free municipal bonds or real estate.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.