When a company goes bankrupt, what happens to your retirement plan depends on what type of retirement plan it is. It also may depend on whether the company undergoes Chapter 7 or Chapter 13 bankruptcy.
All qualified retirement plans are protected under the Employee Retirement Income Security Act (1974). This includes defined contribution plans, such as as the 401(k) and 403(b), and defined benefit plans. ERISA does not cover government- or church-maintained retirement plans, plans maintained outside the United States, and unfunded excess benefit plans.
In general, EIRSA requires a company to keep retirement plan assets separate from business assets. This means that retirement funds cannot be seized by a company’s creditors in case of bankruptcy. However, taxes and early withdrawal penalties for 401(k) plans and other defined contribution plans may apply if the funds are not rolled over into a new plan.
The Pension Benefit Guaranty Corporation (PBGC) was created under ERISA to protect defined benefit pension plans in case of company bankruptcy. This is funded almost entirely through the insurance premiums paid by companies with defined benefit pension plans and by investment returns.
A defined benefit plan pays out a pension based solely on length of service, pay, and age. It is distinct from a defined contribution plan, such as the 401(k), which depends on the amount of money you and your employer pay into the plan, the investment choices you or your employer make, and market conditions. Defined contribution plans are not insured by the PBGC.
All retirement plan assets are subject to market conditions. Usually this means they will increase in value, but major financial collapses or poor investment choices may cause them to shrink. This won’t matter for a defined contribution plan, which will simply pay out the same amortized percentage every time, although the amount of money in that percentage may go up or down. However, the pension amount received under a defined benefit plan is fixed independently of market conditions. With insufficient funding, the plan’s liabilities, including employee benefits, may exceed its assets.
The Pension Protection Act (2006) requires defined pension plans to be fully funded at all times, which means that its assets must equal or exceed its liabilities. This requires a company to pay enough into the plan every year to balance the plan’s assets and liabilities. However, when a company goes bankrupt, it can no longer pay into the defined benefit pension plan so there probably won’t be enough money in the retirement fund to pay all benefits.
A pension plan terminates when a company goes bankrupt under Chapter 7 bankruptcy. It usually also terminates if the company goes bankrupt under Chapter 11 bankruptcy, although this may not always be the case. When a plan terminates without sufficient money to pay all benefits, PBGC takes over the plan and pays the benefit up to the limits set by law.
In 2011, the maximum benefit amount guaranteed by PBGC, for workers who begin receiving payments from PBGC at age 65, is $4,500 per month, or $54,000 per year. If you are younger than 65 years of age, you will receive less. If you are older, you may receive more. The limit is also lower if your pension includes benefits for a surviving spouse or other beneficiary.
A new PBGC rule no longer guarantees benefits earned after the company files for bankruptcy but before the PBGC takes over the plan. Similarly, for the purpose of PBGC pension insurance, an employee’s seniority, pay, and age is now based on the date when the company filed for bankruptcy. This and other new rules were implemented in June 2011 after the PBGC reported several multi-billion dollar annual deficits in a row. Its effects are backdated to all plans which terminated on or after September 16, 2006.