Assessing the Banking Landscape for Self-Directed Investors

The recent failures at Silicon Valley Bank and Signature bank have a lot of investors on edge.  People are wondering if these are isolated instances or if there is a larger threat to the banking system.  Most importantly, savers are wondering if their own money is safe.

Like most in the financial services industry, we have received a lot of panicked phone calls and emails of late.  As such, we wanted to provide what clarity we can about how to ensure your own self-directed IRA or Solo 401(k) can be protected from banking risk.

What Happened?

SVB and Signature were hit with liquidity crises.  They had more requests for withdrawals than available cash to meet those requests.  This is classically referred to as a bank run.

There are several factors that drove these banks to the point of crisis, including a high percentage of business accounts over the FDIC limit in concentrated, at-risk industries like technology and cryptocurrency services.  Because those sectors are in a downturn environment, many firms are relying on cash savings to keep operations going.  These are also both very interconnected and clubby fields where many founders know each other and participate in similar social media forums.  Once word got out that banks were stressed, everyone decided to bail at once, which only exacerbated the situation.

The banks also had asset related risk due to poor timing, less than stellar management, and recent rate hikes by the Fed in an attempt to curb inflation.  Deposits grew significantly at many technology industry associated banks in the Covid-19 era.  Since interest rates were quite low and lending opportunities were limited, a lot of banks parked deposits in safe assets like bonds.

Since bond yields are in inverse correlation to interest rates, those assets have been hit hard and are worth less than when purchased.  So long as those losses are just on paper, there is immediate issue.  In the case of SVB, however, the rising need for customer withdrawals forced them to sell these assets and mark to market at a loss.  Poor messaging around such a liquidation was the snap of a twig that set the herd running in panic.

Where are we Now?

In our hyper-connected and fast-paced news environment, the panic spread rapidly.  The Treasury Department decided to take extraordinary action to make whole all depositors at SVB and Signature in a move to quiet things down and hopefully prevent a contagion of fear.  While that seems to have worked to a large degree, there are signs that other banks such as First Republic are experiencing stresses.

It will likely be some time before we know how large the damage to the financial system will be.

What is at Risk for Investors?

At times like these, it is important to perform a risk assessment.  Poor risk management is a big reason that SVB and Signature ran into trouble.  By being aware and ensuring your savings is well positioned, you can keep yourself safe.

With respect to your self-directed retirement plan, only cash deposits in a plan bank account that are in excess of $250,000 are at risk.

Since Safeguard Advisors is not a financial institution and does not hold client funds, we do not have direct information about how much cash any individual client may be holding.  From our estimates, we expect that less than 2% of Safeguard clients have more than $250,000 of liquid cash in their self-directed retirement plan.

We of course have many clients with larger accounts, but the majority of those plans are invested in non-cash assets like real estate, private funds, mortgage notes, etc.  Once plan funds are invested in such assets, they leave the banking system.

What is Protected?

If you have less than $250,000 cash in a FDIC insured account with your IRA custodian or the bank you use to hold your IRA LLC or Solo 401(k) checking account, then that cash is fully backed by the federal government.

FDIC insurance was created in the wake of the great depression and there has never been a situation where accounts under the FDIC limit have experienced a loss.  FDIC limits have changed over time, and were raised to $250,000 during the banking crisis in 2008.

FDIC coverage extends to $250,000 per depositor, per institution.  A person or entity with a distinct tax ID is considered a unique depositor.

You and your retirement plan have unique tax ID’s, so if you have $200,000 at a bank and your IRA has $225,000 at that same bank, you are fully protected even though the total you hold with the institution is $425,000.

Similarly, if your IRA-owned LLC has $175,000 at one bank and $210,000 at another, it will be fully FDIC insured.

How to Mitigate Risk?

If you are a self-directed investor with a checkbook IRA or Solo 401(k), you may already have one of the best protections in place, which is diversity.  If your plan is holding non-traditional assets like real estate, there is no direct exposure to banking sector risk.  If distress on the banking industry continues and that impacts the economy as a whole, you may see changes in values for non-cash assets, but real assets like property present a significant hedge against financial system risk.

If you have non-cash financial instruments in your retirement plan, you might want to evaluate those positions.  Many money market or cash management funds offered by brokerages, for example, are not necessarily covered by FDIC insurance.

It goes without saying that if you have in excess of the $250K FDIC limit under your plan in a single bank, you will want to consider different options.

Is Your IRA Safe?

Your IRA as an entity is safe, and it not at risk of loss even in the event that the institution holding your account becomes insolvent.  An IRA custodian is largely just a recordkeeper.

If your custodian were to be taken over by the Fed in the event of a collapse, another firm would be appointed to be your custodian and recordkeeper.  The process would be disruptive and quite probably nerve wracking, but after a period of transition, any investments like stocks or real estate would be transferred to the new institution.

Only cash not covered by FDIC insurance would be at risk of loss due to the failure of a particular IRA custodian.

What if Your IRA is Worth More than $250,000?

As a reminder, the total value of your IRA is not what matters with respect to FDIC coverage.  If you have an IRA worth $1.2 million of which 80% is invested into things like stock, real estate, private funds, and other non-cash investments, that means only $240,000 is in cash.  That cash amount is below the FDIC insurance limit.

If you have more than $250,000 in cash, then you may want to consider options to make sure all your cash is protected.

If the overage is short-term due to a recent sale of an asset, and you have an intention to reinvest that money quickly, there probably is not too much to be worried about.

If you expect to carry a balance of more than $250,000 in cash for an extended period of time, getting that protected will make sense.

Self-Directed Plans Allow for Multiple Accounts

One of the great things about a self-directed IRA LLC or Solo 401(k) is that you have a legal entity under the umbrella of your plan that you control.  That means you can open as many financial accounts as you choose, and are not tied to the single institution where you setup the plan like with most conventional retirement accounts.

An IRA owned LLC or Solo 401(k) trust can hold one or more accounts with a range of financial institutions like banks, brokerages, or cryptocurrency exchanges.

If you have more than $250,000 in your main LLC bank account, for example, simply open another account for the LLC at a different bank.  You can just open the account and move the money.  Since both accounts are in the name of the same LLC, there is no IRA type event like a rollover taking place.  That means there is therefore no need for special reporting.

The same is true with a Solo 401(k).  Just open another account if you need to.

Can Cash over $250,000 be FDIC Insured?

Before you move money, check with your current bank.  Some banks offer large account protections through network deposit services such as IntraFi.  While your account is nominally with one institution, the network creates virtual sub-accounts across several institutions.  Those accounts are then individually protected by FDIC.

It is possible to hold multi-million-dollar accounts and remain fully FDIC insured with this tool.

Ask your bank if they offer IntrFi or a similar solution.  There may or may not be a cost for using this service, depending on the bank.

Choosing the Right Banking Partner

Even if you are fully FDIC insured, nobody wants to see their money at a bank that fails.  While there may only be a few days pause before funds are accessible, those days would likely add more than a few gray hairs.

Both of the banks that failed recently had almost 90% of accounts above FDIC limits, and concentrated in a few specific industries.  Working with a bank that has a lower percentage of account holders over the FDIC threshold, a diverse client base, and a solid amount of cash reserves is going to provide better peace of mind.

Safeguard Advisors partners closely with Solera National Bank.  They have been the leading bank specializing in services for self-directed IRA and Solo 401(k) investors for many years.

We currently utilize Solera as our IRA custodian of choice because they offer great service at reasonable prices.

Safeguard IRA plans setup through Solera as custodian come with a built-in LLC or trust checking account at Solera.

Many of our Solo 401(k) clients choose to use Solera because of their excellent service and familiarity with the needs of self-directed investors.  Most big banks just don’t understand self-directed 401(k) plans and may make it difficult to open and maintain an account as a result.

While we love that Solera provides great services, our selection of Solera is also based on the fact that they have smart ownership and a conservative but profitable approach to managing deposits.  In light of recent events, we of course checked in with Solera to revisit their positions and hear their view of the current banking environment.

About half the bank’s deposits are held in retirement accounts.  That is what we like to think of as “sticky” money.  It would be very unusual for a large group of retirement investors to decide they need to pull their deposits all at once.  Unlike what we saw with tech-heavy SVB, a bank run is not likely at Solera.

More than 90% of Solera accounts have cash balances under $250,000 and are fully FDIC insured.  That is a full reversal of the ratio at Signature and SVB.

The investments into which Solera has placed their portfolio of deposits is diverse and productive.  Solera does not have the same kind of high allocation to an overly conservative bond portfolio that turned out to be catastrophic for SVB.

Solera is currently holding about $300 million in liquid reserves and plans to increase that amount to $400 million in light of current events.  For a $1 billion bank, that is a comfortable ratio of reserves.

If you have your IRA or Solo 401(k) checking account at Solera National Bank, your risk is quite low.  If you are concerned about the bank where your plan funds are held currently or have in excess of $250,000 in a single plan account, you may want to include Solera in your consideration for a secondary account.

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