The Federal Deposit Insurance Corporation (FDIC) covers deposits, not investments. This is why 401(k) plans are not FDIC-insured—most are composed primarily of investments, which are riskier.
The good news is that deposits contained within a 401(k) are covered if the plan is administered by an FDIC-insured financial institution. Checking accounts (including money market accounts), savings accounts, and certificates of deposit (CDs) are considered deposits and insured by the FDIC.
- The FDIC covers deposits, not investments, and most 401(k) assets are in the latter.
- Deposits held in 401(k) plans are covered if the assets in question are held by an FDIC-insured financial institution.
- The FDIC insures deposits up to $250,000.
- Deposits include checking, money market, and savings accounts, and CDs.
How the FDIC Works
The FDIC was created in 1933 under President Franklin Delano Roosevelt as a remedy to the bank runs, which were exacerbating the Great Depression and hindering any sort of recovery, and to increase confidence in the financial system.
Banks are at the heart of a successful capitalist economy. Faith and confidence in the banks' ability to make good on customer deposits is a necessary ingredient for credit creation. Depending on interest rates and economic conditions, banks give out a certain percentage of loans against these deposits. However, this would not be possible if customers pulled their money from banks at any moment they felt uncertain.
The FDIC protects bank accounts up to $250,000. Basically, banks pay into a fund. The fund pays for oversight of the banks and is used to compensate deposit holders if a bank goes under.
The net result is fewer bank failures, due to the regulatory oversight and confidence that deposits are safe. Since its inception, no FDIC member bank has lost any customer deposits.
Why Investments Are Not Covered
It is crucial to check with the financial institution that administers your plan to see if deposits in your 401(k) account are covered by FDIC insurance.
If the FDIC were to begin insuring investments in 401(k) accounts, it would lead to excessive risk-taking and distortion of asset prices. This would undermine one of the primary mechanisms of financial markets—price discovery.
It simply is not practical for the FDIC to cover the entire spectrum of possible investments in a 401(k) account without imposing draconian restrictions on the type of investments that can be made. The budget and credit line for the FDIC would have to be dramatically increased for it to have the resources to insure against these investments.
While customers can trust their banks as long as they are FDIC-insured, they must do due diligence when making their own investments to find the optimal balance between risk and return.
How Deposits in a 401(k) Are Covered
The FDIC does insure safer assets held in 401(k) accounts, such as CDs and money market accounts, but only if the assets are held at a financial institution that is FDIC-insured.
For example, if a 401(k) account worth $100,000 has 50% invested in stocks, 25% in bonds, and 25% in a money market account, then the $25,000 in the money market is covered by the FDIC in the event of some catastrophe in which the banking institution goes under.