Are Brokered CDs Safe? How FDIC Insurance Works

Certificates of Deposit (CDs) offer a fixed interest rate for a set period, making them a popular choice for savings. Brokered CDs are purchased through a brokerage firm rather than directly from a bank. Understanding how these instruments function and their safeguards is important for investors seeking to protect deposits while earning a return.

What Brokered CDs Are

Brokered CDs are certificates of deposit issued by banks but available to investors through brokerage firms. Unlike traditional CDs, which are acquired directly from a specific bank, brokered CDs allow investors to access offerings from various issuing banks through a single brokerage account. The brokerage firm acts as an intermediary, facilitating the transaction between the investor and the issuing bank. This provides a broader selection of maturities and interest rates.

When you buy a brokered CD, your funds are deposited with an issuing bank, but your account relationship for administrative purposes remains with the brokerage firm. This streamlines managing multiple CD holdings from different banks within one consolidated brokerage statement. Brokered CDs are debt obligations of the issuing bank, which promises to return the principal with interest upon maturity.

How FDIC Insurance Protects Brokered CDs

Brokered CD safety stems from Federal Deposit Insurance Corporation (FDIC) coverage. The FDIC is an independent U.S. government agency that protects depositors against the loss of insured deposits if an FDIC-insured bank fails. This insurance is automatic for any deposit account opened at an FDIC-insured bank. The standard maximum deposit insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.

FDIC insurance applies to the issuing bank of the CD, not the brokerage firm. If an investor holds brokered CDs from multiple banks within one brokerage account, each CD is separately insured by its respective issuing bank. This allows investors to expand total FDIC coverage beyond the $250,000 limit by diversifying CD holdings across various FDIC-insured banks. For example, an investor could hold $250,000 in brokered CDs from Bank A and another $250,000 from Bank B, both within the same brokerage account, and each would be fully insured.

The FDIC aggregates all deposits an individual holds at the same bank within the same ownership category. If you have a checking account, savings account, and a brokered CD in your name at the same FDIC-insured bank, their combined balance is insured up to $250,000. Different ownership categories, such as single accounts, joint accounts, and certain retirement accounts like IRAs, are insured separately, potentially increasing overall coverage at a single bank. The FDIC’s protection covers both the principal and any accrued interest up to the insurance limit through the date of the bank’s closing.

The Brokerage Firm’s Role and How CDs are Held

The brokerage firm plays a distinct role, separate from the FDIC’s function. While the broker facilitates the purchase and sale of these CDs, they do not insure the principal against the failure of the issuing bank. That protection is solely provided by the FDIC for the underlying bank. The brokerage firm’s primary responsibility is to maintain records and provide access to the CDs within the investor’s account.

Brokered CDs are commonly held in “street name” by the brokerage firm. This means the securities are registered in the name of the brokerage firm or its nominee, rather than directly in the investor’s name, on the issuing bank’s books. The brokerage firm maintains detailed records showing the investor as the beneficial owner. This holding method is standard for many securities and simplifies trading and administrative processes.

Protection against the failure of the brokerage firm itself is provided by the Securities Investor Protection Corporation (SIPC). SIPC protects customers’ securities and cash held in brokerage accounts up to $500,000, including a $250,000 limit for cash, if the brokerage firm fails. It is important to distinguish that SIPC coverage protects against the loss of assets due to a brokerage firm’s insolvency, such as if assets are stolen or records are lost. SIPC does not protect against losses from the failure of the issuing bank, nor against a decline in the CD’s market value.

Other Important Characteristics

Callability

Beyond FDIC insurance, brokered CDs have other characteristics influencing their investment profile. One feature is callability, which grants the issuing bank the option to redeem or “call” the CD before maturity. Banks typically exercise this option if interest rates fall, allowing them to refinance at a lower cost. While investors receive principal and accrued interest up to the call date, they may need to reinvest at lower prevailing rates. Callable CDs often offer a slightly higher interest rate to compensate for this risk.

Secondary Market

Brokered CDs also have a secondary market, allowing investors to sell their CDs before maturity and providing liquidity that traditional bank CDs typically lack. Unlike traditional CDs, which often impose early withdrawal penalties, brokered CDs can be sold without such penalties. However, a brokered CD’s market value can fluctuate based on prevailing interest rates. If rates have risen since purchase, its value may be less than the original principal, potentially resulting in a loss if sold before maturity. Conversely, if rates have fallen, the CD might sell for a premium.