Your 401(k) Plan If Your Employer Goes Bankrupt

If your employer goes bankrupt, how your 401(k) plan will be affected depends on what type of bankruptcy is filed. In a Chapter 11 bankruptcy, your employer attempts to restructure and the 401(k) plan may be continued. But as pointed out by Kimberly Lankford in an article for Kiplinger, as part of the restructuring, your employer may cut back on benefits, such as matching contributions to your 401(k). And, if you have investments in your company's stock in your 401(k) account, you could see a drop in the value.

In a Chapter 7 bankruptcy the company is basically liquidating and your 401(k) plan may be terminated. But according to the Employee Retirement Income Security Act (ERISA) of 1974, the funds in 401(k) plans must be held in a trust or insurance account, separate from other company assets and protected from creditors. So the money in your 401(k) account will be safe, provided your employer has transferred your payroll deductions to the 401(k) plan account. As pointed out by the Employee Benefits Security Administration, it is a good idea to confirm this. You can check your individual statements for your 401(k) account.

As pointed out by Clifton Linton in the 401 Help Center website, you shouldn't lose more than the payroll deductions from your most recent paycheck. The employer is required to deposit payroll deductions in the 401(k) trust account no later than 15 business days following the end of the month when the payroll deductions were made. You could potentially lose employer contributions to your 401(k) plan if your employer goes bankrupt. These contributions, which include matching and non-matching contributions, can be deposited less frequently, such as quarterly, semi-annually, or annually.

When a retirement plan, including a 401(k) plan, is terminated, you become 100% vested in your accrued benefits. You have a right to all benefits you have earned including the benefits in which you were not yet vested and would have lost if you had left your employer. But a potential problem pointed out by Wendell Sherk, Missouri Bankruptcy Attorney, in the Bankruptcy Law Network is that when a 401(k) plan is terminated and the employer is bankrupt, the costs of terminating the plan may come out of the employees' investments in the plan.

Traditional pension plans, which are defined benefit plans, are insured by the Pension Benefit Guaranty Corporation. But this insurance does not apply to defined contribution plans such as a 401(k) plan.

If the 401(k) plan is terminated and the funds are distributed, you can avoid paying federal income tax on the earnings by rolling over the distribution into your new employer's 401(k) plan, if the plan allows rollovers. Or you could roll over the distribution into your own IRA. According to the IRS, you have 60 days to make the rollover. And you should keep in mind that distributions are subject to a mandatory 20% withholding. You can recover that 20% when you file your income tax return, but when you make the rollover you will have to come up with the 20 % from other sources in order to roll over the complete amount of the distribution. Also, if you are younger than 59 '½ and you do not roll over the distribution, you may be subject to a 10% tax for early withdrawal.

If your employer files Chapter 7 bankruptcy, it may no longer be the fiduciary of the 401(k) plan. The employer may name another trustee or if not, the bankruptcy court may name a trustee. As indicated by the Employee Benefits Security Administration, it can be difficult to get information and find a contact for asking questions. The 401k Help Center recommends contacting the 401(k) plan administrator immediately, based on the contact information in the summary plan description. If you cannot obtain the information you need you can contact the Employee Benefits Security Administration.

Sources:

Clifton Linton, If a Company You Work for Goes Bankrupt, What Happens to Your 401k? 401k Help Center

Fact Sheet: Your Employer's Bankruptcy -- How Will It Affect Your Employee Benefits? Employee Benefits Security Administration

Kimberly Lankford, What Happens If Your Employer Goes Broke? Kiplinger

Topic 413 -- Rollovers from Retirement Plans, IRS

Wendell Sherk, Missouri Bankruptcy Attorney, Employer's Bankruptcy Could Hurt Your 401(k) Plan, Bankruptcy Law Network