If your Company is Bankrupt, is your 401(k) Plan in Jeopardy?

A listener posed a question yesterday regarding the Bennigan’s Restaurant closing and whether or not employees lost money in their 401(k) plans because of it.

After doing some research on the story, I discovered a few sound bites from some of the employees mistakenly stating that their 401(k) plans had been tapped for money. The reality is that with extreme exceptions, your 401(k) plans are very well protected in the event that your company files bankruptcy.

If an employer goes out of the business, the 401(k) plan is terminated. When a plan is terminated, affected participants are 100% vested (they own their employer match) in all employer money in their account, regardless of the plan's vesting schedule. Participants are always fully vested in their own contributions. Participants always own their own investment accounts. This means that the money in the plan is now available to be distributed to the plan participants. Under the law, the employer, even in bankruptcy, can't touch the money in the plan. The 401(k) plan money can't be used for any other purpose except to pay benefits and expenses related to the plan.

The 401(k) assets are also protected by law from creditors.

Are there times when money is taken out of a 401(k) plan illegally? Yes, there have been instances in the past where fraud and illegal activity have occurred. However, it is much tougher today to get away with that type of crime.

In extreme cases, the Department of Labor steps in where there is abuse of the retirement funds, but that rarely happens.

What about pension plans? Well those are protected as well but by different means. Pension plan assets are protected up to certain limits by the Pension Benefit Guaranty Corporation. In this case, certain pension plan benefits could result in a loss due to a company going bankrupt. However, for the most part, everything should be covered.

Now there are stories such as Enron where employees lost everything in their 401(k) plans due to a company going bankrupt. That had nothing to do with a company taking the money out. Those losses were a result of an employee being heavily invested in their company stock. As a result of the company going into bankruptcy, the stock plummeted and was virtually worthless. Thus the employee lost their future.

As a rule of thumb, you never want to have more than 10 to 15% of your company stock inside your 401(k) plan. It is just too much risk.

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