What is SIPC Insurance? Everything You Need To Know

It’s been years since anybody’s worried about a financial brokerage firm going under. However, that doesn’t mean consumer protection isn’t important. After all, you never know when the next crisis will hit. Or how bad the damage will be. If you’ve ever wondered what happens to your stocks if your brokerage goes under, don’t panic. You can rest easy knowing that the Securities Investor Protection Corporation (SIPC) protects your investment accounts against loses in case the brokerage firm fails and the assets in the accounts are missing. There are limits to that protection though. So what, exactly, is SIPC insurance? How does it work?

How SIPC Insurance Works

Firstly, the SIPC protection has a $500,000 limit that’s calculated at the time the firm fails. This means that each account will be covered for a maximum of half a million — even if more is missing. There’s also a $250,000 cash limit, which counts towards the $500,000 limit. Let me give you an example.
Let’s say you own $500,000 worth of stocks and $20,000 in cash when your broker failed. If your assets can’t be found for whatever reason, then you will be made whole up to a maximum of $500,000. You still lose a bit in this example, but thankfully recover almost all of your assets.
Now let’s say that you own $50,000 worth of stock and $300,000 in cash instead. You might think you’d get it all back, since the total amount is well under the $500,000 mark. However, there’s a good chance you’ll get $250,000 of your cash back, plus the $50,000 of your stocks.
Secondly, the SIPC protection only guarantees that you’ll get your securities back. It certainly does not guarantee that the value of your securities will stay the same while they sort everything out. Since you won’t be able to sell anything while the mess is being worked out, you could lose a whole lot more — even if your whole account is covered.

The Reality Isn’t as Dire Though

For those of you who have quite a bit saved, these limits sound scary doesn’t it? After all, $500,000 is a lot of money. But many people really have much more than $500,000 in the market? Should you start setting up multiple accounts at different brokerages, just in case?
It’s up to you, of course. However, the reality isn’t as bad as it might sound. In general, brokers failing doesn’t mean that anyone is going to lose anything. Bear Sterns, for example, was sold to JP Morgan Chase — even though its demise was well documented. Even clients with accounts at Lehman Brother’s brokerage arm — which did go under — were able to transfer their assets to another firm without losing a dime. That’s because the law stipulates that customer’s assets must be held separately from the broker’s own assets.

SIPC Insurance is Actually a Rare Thing

It’s only in the rare event that the SIPC needs to step in to help liquidate the firm (because of some type of mishandling of funds where client assets are missing) that the protection would be triggered. You still aren’t necessarily going to lose everything over $500,000, even in this dire scenario. When the SIPC files the application for a broker to be liquidated, the date of their application is used by clients to determine the value of their cash and securities. This is known as each client’s net equity.
Then they will pool all the customer’s net equity that the SIPC is able to locate. That sum will be used to determine how much each client gets back. In the event that 95% of all assets are found, then each client will get back 95% of their net equity — no matter how much they had at the broker firms. Finally, SIPC will reimburse the customers whose net equity is below the SIPC insurance limits.
Before you think that finding 95% seems high, think again. You’ll be happy to learn that since the inception of SIPC in 1971, roughly 99% of total assets that were distributed to investors came directly from the insolvent broker. Additionally, less than 0.1% of claims ever filed exceeded the limit of coverage.

Additional SIPC Insurance Coverage

In addition, some brokerages take out extra insurance policies to further protect their clients. Charles Schwab, for instance, has a policy in place with Lloyd’s of London (and other London insurers) to further insulate their customers from asset loss.
Here’s the language from their website:

“Additional brokerage insurance—in addition to SIPC protection—is provided to Charles Schwab & Co., Inc. accounts through underwriters in London. Schwab’s coverage with Lloyd’s of London and other London insurers, combined with SIPC coverage, provides protection of securities and cash up to an aggregate of $600 million, and is limited to a combined return to any customer from a Trustee, SIPC, and London insurers of $150 million, including cash of up to $1,150,000. This additional protection becomes available in the event that SIPC limits are exhausted.”

I found similar types of additional insurances at Vanguard and Fidelity too. Be sure to double check with your own broker, but it’s safe to say that your money is well-protecting at most major broker-dealers.

You Can Get More SIPC Insurance

On top of all this, you can also increase your protection limits with accounts owned in different capacities. The SIPC website lists these examples:
individual account
joint account
an account for a corporation
an account for a trust created under state law
an individual retirement account
a Roth individual retirement account
an account held by an executor for an estate
an account held by a guardian for a ward or minor.
In fact, they say that you can get additional protection if you simply open accounts with different joint owners. For example, two joint accounts under you and your spouse’s name would be combined to get a maximum of $500,000 in protection. However, your joint account with your spouse will get up to the limit and your joint account with your adult child, for example, will get another limit up to the maximum. So if you have over $500,000 invested in various brokerages, it’s potentially worth it to diversify the ownership of your holdings.

Not Everything is Covered Though

SIPC insurance primarily covers cash and securities. That will be your basic investments like stocks, bonds, ETFs, and mutual funds. However, it’s important to know what isn’t covered too. SIPC insurance doesn’t cover commodity futures, foreign exchange currencies, or even cryptocurrencies — all the rage lately. If you invest heavily in any of these categories, make sure you know how you are or aren’t protected in the event of a brokerage collapse.

The Bottom Line

Hearing that the firm holding all your assets is in financial trouble is, well, troubling. However, it’s very important for you not to panic. Due to SIPC insurance, chances are very high that you’ll get back everything you own. You might just have to be patient.
If your firm ever goes under, then it’s possible that you can still contact them to get instructions on how to transfer your account to another broker-dealer. If not, then follow the SIPC instructions when they step in. Make sure you stay on top of any communications on how to get your assets back. You’ll likely want to make adjustments to your investments as soon as you have access to them, so don’t procrastinate.