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If a Company You Work for Goes Bankrupt; What Happens to Your 401(k)
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By Clifton Linton
Senior Writer, mPower |
Even as Enron corporation declared bankruptcy and
employees saw their 401(k) plan balances dwindle, ironically, those assets were never at
risk of being seized by the company's creditors and litigants. One thing the energy
firm's financial collapse illustrates is how federal laws protect 401(k) assets when a
business goes bankrupt.
It seems that every week brings fresh bankruptcy
declarations from other companies. While workers at these firms may suffer layoffs and
loss of income, fortunately federal law protects most, if not all, of their 401(k)
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 401(k) 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.
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| "Whatever is in the trust is not
the property of the (bankruptcy) estate and not subject to liquidation." |
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| Judge Alexander Paksay, chief judge
emeritus with the U.S. Bankruptcy Court's middle district in Florida |
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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, 401(k) 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/401(k) 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 401(k) 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 401(k) 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
401(k) 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
Pension Welfare and Benefits Administration, which helps reconnect orphan 401(k) accounts
with their rightful owners. You can reach the PWBA at (202) 693-8300.
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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.
mPower is the
premier online community resource for 401(k) participants
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