SIPC insurance: What it covers and how it protects investors

The collapse of Silicon Valley Bank and Signature Bank in March 2023 caused depositors to reassess whether their assets are safe at certain financial institutions. While the federal government has adopted new programs to shore up confidence in the banking system, investors may be wondering how their money is protected in the unlikely event their brokerage firm fails. Thankfully, that very situation is what the Securities Investor Protection Corporation (SIPC) serves to safeguard against.

The SIPC is a federally mandated, private nonprofit organization. It was created as part of the Securities Investor Protection Act (SIPA) of 1970, which looked to shield investors from brokerages becoming insolvent. Today, SIPC insurance covers investors for up to $500,000 in securities and up to $250,000 in uninvested cash.

While that is what the SIPC does in a nutshell, there is more nuance to how it works. We’ll cover those details here.

What is SIPC insurance coverage and how does it work?

SIPC coverage insures people for up to a limit of $500,000 in cash and securities per account. SIPC protections also include up to $250,000 in cash coverage. The total amount of SIPC coverage is $500,000; thus, if you have $500,000 in securities and $250,000 in cash, that entire amount may not be covered.

However, there are circumstances in which investors are covered for more than $500,000. This happens primarily when investors have multiple accounts of different types. For instance, if you have a traditional individual retirement account (IRA) and a Roth IRA at the same brokerage, the SIPC will insure them separately. Thus, you will be insured up to $1 million between the two accounts.

Of course, SIPC insurance only comes into play under circumstances in which the SIPC must intervene. This happens when it receives a referral from regulatory agencies such as the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Agency (FINRA). If a broker-dealer fails and customers have lost securities and/or cash, the liquidation process will begin.

During the liquidation process, the SIPC asks the court to appoint a Trustee to liquidate the firm. The Trustee can either be a lawyer with relevant experience or it can be the SIPC itself for smaller cases. In very small cases, the SIPC may deal with customers directly outside of court in a direct payment procedure.

What SIPC insurance protects

SIPC insurance covers specific types of investments as securities. Some examples of securities are:

• Stocks
• Bonds
• Treasury securities
• Money market mutual funds
• Certificates of deposit

Each of these securities is covered under what the SIPC calls “separate capacities.” In essence, separate capacities are just different types of investment accounts. Some examples of separate capacities are:

• Individual accounts
• Joint accounts
• Trust accounts
• Corporate accounts
• Traditional IRAs and Roth IRAs
• Accounts held by an executor of an estate
• Accounts held by a legal guardian

These are some, but not necessarily all, of the types of securities and capacities covered by the SIPC. However, you should always check with your brokerage for further specifics or types of accounts not mentioned here.

What SIPC insurance doesn’t cover

There are a few major types of losses SIPC insurance does not protect against. These include:

• Losses due to market volatility
• Losses due to bad investment advice
• Losses due to security breach, unless the brokerage becomes insolvent

On that last point, note that if the brokerage becomes insolvent due to a hack, the hack itself is irrelevant. If the brokerage becomes insolvent, you may be covered just as you would in any other scenario where a brokerage is forced into liquidation.

In addition to these scenarios, there are specific types of assets that SIPC insurance doesn’t cover. They include:

• Commodity futures contracts (unless they are held in a special portfolio margining account)
• Foreign exchange (forex) trades
• Fixed annuities contracts
• Investment contracts such as limited partnerships

SIPC vs. FDIC: How they compare

While the SIPC and Federal Deposit Insurance Corporation (FDIC) are similar in terms of how they work, they have different purposes. The SIPC protects investment account owners, while the FDIC protects deposit account owners. In the wake of the collapse of Silicon Valley Bank and Signature Bank, the federal government announced plans to guarantee 100 percent of deposits held at the failed institutions.

Is it safe to keep more than $500,000 in a brokerage account?

It is safe in the sense that there are measures in place to help investors recoup their investments before the SIPC steps in. And, indeed, the SIPC will not get involved until the liquidation process starts. In most cases, customers can recover their assets without having to file a claim with the SIPC.

In most cases, the brokerage will liquidate on its own without needing SIPC intervention. In addition, brokerage firms are required to keep customer funds in accounts separate from their own. They must also have a certain amount of liquidity on hand, thus allowing them to cover funds in these cases.

What this means is that even if you have more than $500,000 in one brokerage account, chances are high that you won’t lose any of your money even if the broker is forced into liquidation.

That being said, if the firm refuses or is unable to self-liquidate and the SIPC must step in, you may not be able to claim more than your $500,000 in securities and cash. Therefore, the safest option is to move your money above that $500,000 SIPC coverage threshold to a different type of account, or to a different brokerage altogether. (Here is our list of the best online brokers.)

Investors with multiple accounts at the same broker

If you have multiple accounts at the same brokerage, each separate type of account will be insured up to the $500,000 amount, including $250,000 in cash. The SIPC considers these separate capacities and thereby insures each account independently. But if you have multiple accounts of the same type at the same brokerage (such as two individual accounts), they will not be insured separately.

In other words, if you have an individual account in your name and a joint account with your spouse, both accounts will be covered for the $500,000 amount. That means that between the two accounts, you will have $1 million in coverage, including up to $500,000 in uninvested cash.

Two accounts are not insured separately if they are the same type. Two brokerage accounts in your name would be considered one ownership capacity; thus, the two accounts together are covered for $500,000 in securities, including $250,000 in cash.

On the other hand, if you have two individual accounts at two different brokerages, those accounts would be insured separately.

What happens if your brokerage goes out of business?

If your brokerage firm goes out of business, there’s a good chance it will be acquired by another company and your assets and securities will be transferred to the new custodian through a relatively seamless process. 

If the broker fails and no firm steps up to acquire it, the court will appoint a trustee to close the brokerage firm’s offices and take control of the firm’s financial records. Under the SIPC’s supervision, the trustee gathers customer information and sets up a process for claims to be filed. In some cases where the claims are all covered by SIPC insurance, a direct payment procedure may be used that doesn’t require a trustee. 

Bottom line

The SIPC is a federally mandated, private non-profit that insures up to $500,000 in cash and securities per ownership capacity, including up to $250,000 in cash. If you have multiple accounts of a different type with one brokerage, you may be insured for up to $500,000 for each account. Note that multiple accounts of the same type at the same brokerage will not be insured separately.

While SIPC insurance is critically important, you won’t necessarily need to file a claim even if your brokerage is forced into liquidation. These firms often choose to self-liquidate and in doing so transfer funds back to their customers. Also, they are required to keep extra cash on hand to help in these cases.

Nevertheless, SIPC insurance is an important safeguard to have in place so investors can rest easy knowing their money is protected in the event that their broker fails.

— Bankrate’s Brian Baker contributed to an update of this story.