If a Company You Work for Goes Bankrupt, What Happens to Your 401k
It seems that every week brings fresh bankruptcy declarations. While workers at these firms may suffer layoffs and loss of income, fortunately federal law protects most, if not all, of their 401k savings.
The Employee Retirement Income Security Act (ERISA) provides these protections by requiring the plan assets to be held in a trust account, apart from the employer's assets. This separation means employees are not allowed to access 401k savings without following the trust's rules, and employers may not use this money to fund business operations. This also keeps the money out of the hands of the employer's creditors.
"Whatever is in the trust is not the property of the (bankruptcy) estate and not subject to liquidation," explained Judge Alexander Paksay, chief judge emeritus with the U.S. Bankruptcy Court's middle district in Florida.
Funds at Risk
If your employer declares bankruptcy, all of your contributions that were safely in the plan prior to the bankruptcy filing are protected. Likewise, all vested employer contributions are protected. In some cases, unvested employer contributions may become fully vested if your employer lays off a large number of employees within a year, generally at least 20 percent (known as a "partial plan termination").
That said, there are two circumstances in which you may not receive all the money you thought was due you.
The first is if your employer didn't deposit your contributions before declaring bankruptcy. Typically, this should only affect one paycheck's worth of contributions, since Department of Labor rules require that all employee contributions must be deposited in the trust as soon as possible, and at the extreme no later than 15 business days following the end of the month when the contributions were made.
The second is when an employer match hasn't been deposited into the trust. Employer contributions (matching or profit-sharing) may be deposited less frequently than employee contributions -- quarterly, semi-annually or even annually. Employers are allowed to make matching contributions until their tax-filing deadline, which can be months into the next calendar year. If the employer hasn't made its contribution to the plan before bankruptcy is declared, the contribution may be lost.
Bankruptcy Priorities
The U.S. bankruptcy code allows businesses to either reorganize debts or shut down in an orderly fashion so creditors can be paid. The bankruptcy system establishes the priorities of creditors, said Wesley Avery, a bankruptcy attorney with Sulmeyer, Kupetz, Baumann & Rothman in Los Angeles.
Unpaid workers' salaries have high priority in claims against a firm -- behind only the IRS, which wants any outstanding taxes, and the attorneys and accountants who help with the bankruptcy filing. Workers are ahead of any creditors, secured or unsecured, meaning the likelihood they will be paid is pretty high.
"Congress viewed employees as having a special right to payment (because) their labor helped create assets from which other creditors will be able to realize value and because their wages are typically their sole source of income," Avery said.
Surprisingly, 401k contributions deducted from an employee's paycheck but not deposited into the account are not priority claims. Employees must get in line with other creditors for the return of this money. David Wray, president of the Profit Sharing/401k Council of America, said his organization is urging Congress to recharacterize this money as unpaid salary, since it came out of workers' paychecks.
Bankruptcy Types
Bankruptcy filings freeze all the assets of a company while the business and its creditors sort out restitution. What happens to a 401k plan depends on the type of bankruptcy protection an employer seeks -- Chapter 11 or Chapter 7.
Chapter 11 bankruptcy is a debt reorganization in which the business expects to continue operating. It is the most common type of bankruptcy filing by businesses. Enron filed for Chapter 11.
Workers whose employer files for Chapter 11 bankruptcy likely will see their plan continue operating. Indeed, Enron's current employees can still contribute to the plan, and former employees can request distributions in order to cash out or roll the money to an IRA or a new employer's plan that accepts rollovers.
In Chapter 11, the employer may amend the plan document and reduce future employer contributions, said Donald Black, president of MBM Advisors, Inc., an investment advisory and pension consulting firm based in Houston.
A business that files Chapter 7 bankruptcy intends to close its doors. This is a rarer filing, Paskay said. In this case, the employer stops operating and no longer serves as plan fiduciary. The plan also stops operating and all assets need to be distributed to former employees. For this to happen the plan still needs to be administered by a trustee authorized to remove assets from the trust and distribute them to participants.
Sometimes the employer may name a new trustee. But, if the company shutdown is quick and all the company officers vanish, the bankruptcy court will appoint a new plan trustee to oversee the plan's termination. Some employers file a formal termination with the IRS, while others simply close the plan.
If the plan is expected to close and only the trustee is changed, employees may be locked out of the plan for a week or two while a new trustee is named to handle distribution of the assets. Participants could not make new contributions or take a withdrawal during that time.
If the employer files for a plan termination (a formal process that is not required) it could take six months or more to get IRS approval. During this time employees may not make contributions to or withdrawals from the plan. When the termination is approved, all employees become fully vested, said Stephen Mueller, president of Hand Benefits & Trust of Houston, and money is distributed to plan participants.
Even if the plan doesn't file a formal termination application, if the plan is closed all unvested employees should become fully vested.
Officially terminating a plan helps ensure that the employer ties up any loose ends and fulfills all of its fiduciary responsibilities.
If your employer never files for bankruptcy but merely locks the doors and is never heard from again, you and your coworkers may have to petition the bankruptcy court to appoint a new trustee to close the plan. This typically happens only in sole proprietorships and small partnerships, according to experts interviewed for this article. The amount of time it could take to get a court-appointed trustee, file for termination and get your money distributed depends on how fast the bankruptcy court works.
It's unlikely that your employer could abscond with all of your 401k savings, since you should have account statements showing deposits. If you are not seeing deposits made in a timely manner you should ask your employer for an explanation. If you don't get a satisfactory one, contact the plan provider and ultimately the Department of Labor.
Your Strategy
If your employer, or a former employer still holding your 401k savings, has declared bankruptcy, contact the plan administrator immediately. Don't wait for it to contact you, said Wray. "The sooner you act, the better off you are," he said.
Explain that you are a plan participant and provide your updated contact information. This way, you'll receive mailings related to the plan and any possible termination documents. When it comes to distributing savings, yours should arrive in timely fashion.
Keep copies of quarterly statements and pay stubs showing your plan contributions. Retain the summary plan description you got when you enrolled in the plan. That lists the people and firms that administer the plan and its assets.
This information can be helpful if you don't find out about a former employer's bankruptcy until long after the fact. If you have trouble locating your former plan, be assured that your savings do not go away. Some plans turn over the money to the state when missing participants can't be found, Wray said.
Having your summary plan description and the tax ID number of your former employer can be helpful in finding your money. Try contacting the former plan trustee for help. If you run into a dead end, contact the Department of Labor's Employee Benefits Security Administration, which helps reconnect orphan 401k accounts with their rightful owners. You can reach the EBSA at 866.444.3272.
This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.
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