401(k) risk: Money in limbo due to employer bankruptcy
Retirement dough can be tied up or you could be hit with high fees
By Gary Foreman
The New Frugal You
Dear New Frugal You,
read about this case where a 401(k) wasn't safe. Seems like the employer went
out of business and now people can't get their money out. What about me? Is mine safe? I'm
depending on my 401(k) for my retirement. Is that a mistake? -- David
right to be concerned about the safety of your 401(k) plan. For many of us, our 401(k)
plan is intended to be a major source of retirement income. It's important to
protect that asset. So let's take a look at what dangers there could be to your
How 401(k) plans work
begin, let's review how a 401(k) plan works. They were created by The Revenue
Act of 1978. An employer must set up the plan. They will choose an
administrator to handle the operation of the plan. The administrator is
responsible for protecting your money and investing it per the law and the plan
can contribute a portion of your salary to the plan on a pretax basis. Anything
you contribute is not counted as current income for this year's federal income
money stays in the plan any earnings are not taxable. You'll be taxed when you
take the money out of the plan.
employer may choose to match some or all of your contributions. They're allowed
to put some restrictions on the money they contribute. A common restriction is to
impose a "vesting period." It requires the employee to stay with the
company for a certain period before the employee gains the right to fully own the
company's contribution. When the requirement is met, the money is said to be
administrator will offer you a variety of investment options. They'll have
control over which ones are made available. Common choices are stocks, bonds,
mutual funds, CDs and money funds.
also allow you to borrow money from your 401(k). In that case, you're required
to pay the loan back just like any other.
Risks of 401(k)s
we've looked at how the plan works, let's see where the dangers lie.
There are two
potential sources of risk in your 401(k) plan:
- The risk that the assets that you're invested in lose
- The risk that bankruptcy or theft takes the money from
risk was demonstrated at the beginning of the 2008 recession. Many stock
investors saw their account balance plummet as the market tanked.
The risk is
exactly the same as it would be with an investment outside a 401(k). Some
investments are safer, but pay less. Others have more potential, but carry
greater risks. Bottom line? No investment is more or less safe simply because
it's in a 401(k).
risk, an employer's bankruptcy or theft, is probably scarier but much less
likely to affect your money. Part of the reason it's more frightening is that
we don't understand what happens to a 401(k) when the sponsoring business goes
through a bankruptcy.
Your company can
go bankrupt, but none of the people it owes money to have access to your 401(k)
assets. You are not liable for company debts and your 401(k) cannot be used to
employer goes bankrupt and liquidates, the 401(k) plan will be terminated (as
will your job). The company is supposed to promptly turn control of the money
over to a trustee. All terminated employees will have the opportunity to take their
money or roll it over into another approved retirement plan, and it's supposed
to take place in no more than a year.
opportunity so that you have greater control over your retirement savings.
Rolling it into a self-directed individual
retirement account will allow you to select plan sponsors
and have the widest possible choice of investment options.
your employment was terminated, you'll will lose any unvested portion of the
employer's contribution -- the same as if you had left the company for another
get all of your contribution. Any investment gains or losses will affect how
much your contribution is worth at that time.
probably also face some risk if you have company stock in your 401(k). Many
companies contribute company shares as part or all of their contribution. Often
they restrict your ability to sell those shares within the plan.
stock in a bankrupt company isn't worth much. Anyone reading this should avoid
this problem by never overloading a 401(k) with any one company's shares. No
matter how much you believe in your employer, spread your risk and periodically
sell off company shares. Ask any former Enron employee whether they wished they
had sold their company shares as soon as they could.
finally, as with the case you cite, it's also possible for the administrator to
go bankrupt, or for the trustee to drag its feet. Again, your 401(k) money
cannot be used to pay their debts.
trouble comes in while your money is in limbo. It's a big deal for older
account holders: Those near the required minimum distribution age of 71-1/2
must make minimum withdrawals yearly, and face big penalties from the Internal
Revenue Service if they fail to do so.
addition, your fees could skyrocket under the new administration. In the case
you cite, one former employee got hit with administrative fees of $24,000 for
you're right to be concerned about your 401(k) retirement plan. And while your
biggest risk is still from the investment choices you make, you've put your
finger on another rare, but significant one.
would be a good time to check up on the health of your employer, and to keep an
eye on it.
See related: Be wary of 401(k) loans, Don't use 401(k) savings to pay off card debt
For more than 35 years, Gary Foreman has worked to help people get the most for their money. Prior to founding The Dollar Stretcher.com, he was a financial planner and purchasing manager. Gary began The Dollar Stretcher website and newsletters in April 1996. Today the website features more than 6,000 articles on different ways to live better for less. Gary has been interviewed by The Wall Street Journal, The Nightly Business Report, USA Today, Reader's Digest and other newspapers and magazines. Gary answers a question about a budgeting or saving issue from a CreditCards.com reader each week.
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Published: September 13, 2012