Direct deposit of Social Security checks: safe, fast – and disastrous

Michele Severin says she has thousands of dollars in credit-card debt and no way to pay it. A single mother in Brooklyn, she and her young daughter live on $1,300 a month in government Social Security disability payments – far less than the $50,000 a year she earned as a New York City bus driver before an injury in 1989 knocked her off the job.

To protect herself from creditors, she considered filing for bankruptcy, but the attorneys' fees were too high for her and she figured creditors couldn't garnish Social Security. Assuming the money was safe, she set up direct deposit, which is less expensive, more secure, and faster than depositing the money in person. But in March 2005, her bank froze the funds, and Ms. Severin, unable to pay rent, found herself in court fighting an eviction.

Severin's case is not unique. As the federal agencies begin another push for recipients to accept their Social Security checks by direct deposit, consumer advocates point to a little-known risk of using the system: Recipients who have judgments against them are vulnerable to losing access to their money.

The problem, advocates say, isn't the direct-deposit system, but the failure of banks to implement safeguards to protect accounts with exempt funds from being frozen.

Now some state courts are requiring financial institutions to verify that an account does not contain 100- percent exempt funds before freezing it, and legal aid attorneys are bringing lawsuits to force banks to ensure that the money they restrain can legally be garnished.

Banks say they are caught in the middle of a legal dispute that is not their responsibility to resolve.

For people living on Social Security, losing access to their bank account can be devastating, community advocates say. "When someone has an account which is exclusively made up of Social Security funds, it's likely these are their only funds," says Margot Saunders, counsel for the National Consumer Law Center (NCLC). "When their accounts are frozen, they have no money to pay rent, buy food, transportation, or go to the doctor."

Although no hard data exists on the amount of exempt funds frozen by creditors, community advocates say it's a serious issue. "This is an exploding problem," says Ms. Saunders, noting that legal task forces in several states are working on the problem.

In January, the federal government began a year-long campaign dubbed "Countdown to Retirement" to encourage new Social Security recipients to choose direct deposit. Cases of lost or stolen checks and fraud are far less common with direct deposit – and the government saves about 80 cents a payment. Direct deposit is a win-win situation, unless the recipient has bad debts.

Many low-income people find it difficult to navigate the legal system, community advocates say.

"Are we going to burden those who are already vulnerable, or are we going to put the burden on the parties who can better absorb the extra effort ... the banks and the judgment holders of debt?" says Gina Calabrese, associate director of St. John University's Elder Law Clinic.

For Severin, losing access to her account was a nightmare. Getting across the city to meet with her lawyer was physically painful, as was going to court to fend off her eviction. It took Severin six weeks to have her funds released, during which she had no access to two months of Social Security payments.

In 2004, Virginia courts were the first of a handful of state courts to amend restraining notices to prohibit banks from freezing accounts that contained only exempt funds. But after the Virginia Bankers Association (VBA) met with court officials to argue that the change flouted Virginia law, the court reinstated the old forms.

In other states, consumer attorneys are attempting to get banks to change their practices through litigation. Severin's lawyer, Johnson Tyler of South Brooklyn Legal Services, is cocounsel for a suit alleging that a New York law requiring banks to honor restraining notices without finding out if an account has exempt funds violates consumers' due-process rights. A suit in North Carolina alleges that Wachovia bank's honoring of restraining orders on accounts having exempt funds is illegal.

Banking associations say banks shouldn't have to determine if funds should be frozen. "Putting banks in a position of acting like a judge in determining whether funds are exempt is an unfair requirement to put on private entities," says Jay Spruill, VBA's general counsel. The decision isn't always cut and dried, he says: Social Security funds aren't exempt from garnishment for tax restraints and child support, and accounts may contain both exempt and nonexempt funds. And if banks mistakenly freeze or fail to freeze funds, they open themselves up to a lawsuit from the aggrieved party, he notes.

Though many who bring the restraints to the attention of their creditors have the dispute resolved within days, people who get Social Security payments by direct deposit stand to lose access to more money, for longer, than those who get a paper check. Two Social Security payments may be deposited into a frozen account before an account holder can switch to a paper check.

Some banks, however, have implemented systems to protect Social Security funds from improper garnishment. New York Community Bank (NYCB) checks to be sure an account does not consist of exempt funds before freezing it. In an affidavit, John Fennell, NYCB vice president, said the policy "has been effective in protecting depositors" and has not been a burden to the bank.

California and Connecticut have laws prohibiting banks from restraining a certain amount of funds in accounts containing directly deposited Social Security payments.

Some advocates say it's in a bank's interest to restrain accounts. Banks receive substantial fees to freeze an account and for bounced checks, says Mr. Tyler, staff attorney at South Brooklyn Legal Services. Severin was charged $380 in bank fees relating to her restraint, money Tyler eventually recovered.

Attorneys representing the banks against which Tyler is bringing the New York lawsuit would not comment on issues surrounding ongoing litigation, but bank fees "absolutely did not" enter into VBA's decision to oppose the new restraining notices, says Phil Boykin, VBA's vice president and director of government relations.

In the meantime, Tyler has warned Severin that her account is likely to be frozen again, since creditors can issue a new restraining notice after a year. Severin's account was refrozen a second time last April. But now she's prepared: While she still receives her Social Security payment by direct deposit, every month she gets a paper check from Social Security for her daughter.

"Every month, I physically take my daughter's paper check to the bank," she says. "That way, I won't be totally devastated without any cash."