In the three months up to December 2013, 7,556 American businesses filed for bankruptcy. While this figure seems low compared to the 230,582 non-business filings, it's worth remembering that these companies employed thousands of people, leaving many employees wondering what will happen to their benefit packages. While bankruptcy often means the end of your job, it's not always clear what will happen to your retirement plan. Find out how bankruptcy affects your retirement investment and how the law protects different types of plan.
How different bankruptcy types affect companies
When a company files for bankruptcy in the United States, the process commonly follows one of two paths.
Chapter 11 bankruptcy occurs when the company continues to trade. In this case, the business will continue under court protection and will reorganize its affairs. Chapter 11 bankruptcy occurred for 22 percent of the businesses that filed in 2013. Company benefits are likely to continue.
Chapter 7 bankruptcy occurs when the company liquidates its assets and ceases to trade. In this case, company benefits (including retirement plans) will cease. In 2013, 69 percent of businesses that filed for bankruptcy followed this route, so it is the situation that most employees are likely to face.
Federal protection of traditional pension plans
The federal government established the Pension Benefit Guaranty Corporation (PBGC) in 1974 to protect consumer pension plans. The PBGC insures private-sector employees and retirees across the United States and guarantees that you will continue to receive basic benefits if your employer files bankruptcy.
If the company files bankruptcy before the pension plan has the cash to pay minimum benefits, the PBGC will normally pay you any guaranteed benefits. Your company's pension summary plan should tell you if the PBGC offers you protection. The PBGC protects most plans that guarantee a monthly benefit, but exclusions include profit-sharing plans, 401(k) plans, and professional service employers (such as lawyers) with less than 26 employees.
PBGC protection guarantees you will receive:
- Pension benefits on normal retirement age
- Annuity benefits for your family
- Disability benefits
- Early retirement benefits
The PBGC cannot protect severance packages, vacation pay, lump-sum death payments and other benefits. PBGC protection applies under chapter 7 or chapter 11 bankruptcies.
Protection of profit sharing and 401(k) plans
The PBGC does not protect profit sharing and 401(k) plans, but the Employee Retirement Security Act (ERISA) makes sure that you don't lose these benefits if your employer files for bankruptcy. Under ERISA, employers must properly fund pension benefits, and they must also keep pension investments separate from the employer's other assets. As such, if the company files for bankruptcy, creditors cannot claim pension funds.
Unfortunately, ERISA does not protect deferred compensation plans. These plans offer high earners a tax break by allowing the employee to defer his or her salary until he or she is in a lower tax bracket. This often only happens during retirement. The company does not hold these funds separately from other financial assets, so bankruptcy law treats deferred compensation as an asset. As such, creditors can claim this money.
Chapter 9 bankruptcy
According to the Bankruptcy Code, cities and counties can file for Chapter 9 bankruptcy, and a number of American municipalities have taken this step in recent years. This leaves employees facing as higher risk of pension loss than private-sector employees.
In October 2014, a bankruptcy judge ruled that bankruptcy law supersedes pension laws in California and ruled that the municipality could cut future worker retirement payments to pay its debts. In these cases, public sector workers do not have the same protection as their private sector counterparts, and could lose all retirement benefits.
If your employer files for bankruptcy, you need to make sure you understand exactly what will happen to your retirement benefits. Contact a bankruptcy attorney to find out how you can protect your investments.