What Happens to My Pension if My Company Goes Bankrupt?
If you’re lucky enough to have a pension through your employer, you’re probably wondering what effect this significant economic downturn will have on your benefit. What happens if your employer goes bankrupt? What does it mean if they freeze your pension? Can your pension benefit just disappear? And where do you go if your employer does go out of business and how can you receive what you’re entitled to?
These are important questions, and if you’ve accumulated a decent pension benefit, you certainly want to be able to get what is owed to you, and understand what companies can and can’t do.
Defined Contribution vs. Defined Benefit
If you take part in a 401(k), 403(b), 457, or other similar employer-sponsored plan, then you’re using a defined contribution plan. This just means that you (and/or your employer through a match or profit sharing) contribute a specific amount of money into the plan. The amount of the benefit is not defined as the investment choices you make and amount you contribute will ultimately dictate how much you receive in retirement.
Pensions are defined benefit plans. These types of plans pay out a defined benefit that is based on a calculation. The calculations usually takes into account length of service, pay, and your age. The benefit that is defined is paid out to you, and it doesn’t depend on how much money you or your employer puts into it or market conditions.
Defined Benefit Plans and Investments
Even pension plans invest in the stock market, and since you don’t make the investment choices, there isn’t much you can do. Your benefit will be determined by the calculation that was established by the plan. So, if the market takes a big hit like it has recently, your pension benefit doesn’t decrease like the value of your 401(k) did.
But, a shortfall in funds has to come from somewhere. Since pensions are funded by the company, a shortage of funds to pay out the benefits could eventually affect you. When a company is forced to inject millions or billions of dollars into a pension plan, it can put strain on an already struggling company. A less profitable company can turn to layoffs, reducing workforce, closing plants, or a number of cost-cutting measures.
In addition, the company may decide to freeze their pension plan. When this happens, any additional service you have with the company wouldn’t be added to increase your pension benefit. You’re still entitled to any benefits you obtained previously, but additional time won’t mean additional benefits. A pension freeze may be temporary or permanent. While it isn’t an ideal situation to be in, at least you will get what you earned prior to the freeze.
If Your Company Goes Bankrupt
Most people assume that if their employer goes out of business, it takes their pension plan with it. In most cases, this is not true. Are you familiar with FDIC insurance limits for bank deposits and SIPC insurance for investment accounts? Both the FDIC and SIPC insures your money up to a certain amount in the event the company that holds these accounts goes under. Thankfully, pension plans have similar protection.
The Pension Benefit Guaranty Corporation, or PBGC is responsible for insuring your pension benefits. In most cases, your pension benefit would be insured up to certain limits. For 2009, a 65 year old has a maximum insured benefit of $54,000 annually. So, as long as your pension benefit is equal to, or less than this limit, you’d still have your full pension benefit even if your company goes under or the pension plan terminates.
Just like banks pay premiums to obtain FDIC coverage, pension plans also pay premiums to the PBGC, and in the event of a failure, the PBGC would take over the plan and administer it while paying out insured amounts. Some types of benefits are not guaranteed. These include health and welfare benefits, severance benefits, lump-sum death benefits and disability benefits when death or disability occurs after plan termination.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
I did not see ANYwhere in this question, if 401K's (and any company matching contributions) are protected if comany goes bankrupt. Can someone please address this simple question? THANKS!
This information makes one feel a bit more secure about the returns individuals will get for the effort they put in. It still continues to make for less than positive news when companies find loopholes in order to provide a fraction of the amount that was set to be deposited into worker accounts during bankruptcy time.
It's interesting to note that amidst the supposed financial crisis that an overwhelming majority of banks and pension funds are actually solvent. I put a lot more trust in the small- to mid-sized financial institutions. They're more apt to play the game conservatively because they know they're not getting a bailout. I handle my IT services 401(k) contribution through spinsurance.com They're solid, accesible and I think less centralized finance centers are the wave of the future unless the goverment keeps propping up the dinosaurs.
Kelley - Excited to see someone arguing for DB plans. It makes a for a good discussion. I was thinking this would be a one sided discussion. I agree with a couple good points you made. 1) Private sector employees can be as lazy as public. (In some cases lazier). 2) Some people aren't as capable of making prudent 401k decisions so there is some benefit to taking it out of their hands.
That said, I would rather have gov't employees eliminate DB plans and replace them with 401ks. In all honesty the cost of DB plans are staggering when compared to DC plans. When I look at my property tax bill literally 15-20% of it goes to pay for pensions of gov't employees. (I live in Chicago so admittedly the number of gov't employees is a bit bloated there.) But I'm sure it is very high in many other locals as well. Just look at what DB plans have done to the Big 3 automakers. They have been crushed over the years by their pension plan obligations. Admittedly they have other issues but it is hard to succeed when you start with that big of a hole...
I made an error in my post above. The second paragraph should be:
Who benefits when an employer switches to a DC plan? The EMPLOYER. Who loses? The employee.
I take exception at your categorization of DB plans as "more expensive." If employee recruitment, retention and security are not important to you, then you probably will argue against DB plans.
Who benefits when an employer switches to a DB plan? The EMPLOYER. Who loses? The employee.
As a govt employee, my DB plan is a big light at the end of the career tunnel. (I also contribute to a 457 Plan.) I earn less salary than I would in the private sector and am constantly fighting stereotypes that govt workers are lazy and inefficient. Workers in ANY industry/field can be lazy and inefficent. Yes, I could make more if I went to work in the private sector, but there is not an equal job in the private sector plus I find my govt/nonprofit jobs very rewarding because I am improving/giving back to my community.
Please also consider the current market situation and how that affects workers with DC plans. This quote from Employee Benefit News sums it up: "The current environment underscores some latent employer risks with 401(k) plans," says Alan Glickstein, a senior retirement consultant at Watson Wyatt. "For example, they make it harder for companies to predict who will retire and when. Employees who mostly rely on 401(k)s are also more likely to worry about their financial security, creating an additional drain on morale and productivity during turbulent times."
There is more research defending the value and true expense of DB plans, but I don't have them at my fingertips.
I hear you Financial Fellow. I wish more public sector employers would do that as well. At the very least, they should do what my wife's plan does. She works for a local government, and her defined benefit plan is more or less a hybrid. It's a defined benefit that is guaranteed and is based on length of service, pay grade, and all of that, but each employee is required to contribute 3% of their pay towards it. This reduces some of the burden placed on taxpayers for funding these accounts.
The bad news is that you can sort of view it like Social Security, since you're just being forced to put money into something that you have no control over. I guess as long as things work out and you get what you're owed, it's fine. But at the same time, I think we could do better with that 3% on our own.
All things considered, they also offer a 457 plan, so you can at least control most of your employer-sponsored retirement benefits. And if the mandatory 3% that you have to put in guarantees a reasonable pension without having to significantly generate funding through taxes, it's not so bad.
I guess the same thing could be said for a lot of unionized labor such as the big three automakers that provide ridiculous retiree benefits (in relative standards). These very generous pension plans and retiree health benefits are unsustainable, and it's becoming obvious that they are at a tremendous competitive disadvantage having to fund these programs. Great for employees, and a noble concept on paper, but companies can't be in the business of completely funding the now 25+ years of retirement that many people are enjoying.
Nice article, Jeremy.
Pension plans for public employees is a real sore spot for me. Pension plans are hugely expensive. Which makes it understandable that private corporations have overwhelmingly dumped them in favor of defined contribution, 401k plans. Where I get sore over pension plans is when we look at public employees. Looking at my property tax bill it becomes immediately apparent that a significant portion of my property taxes go to pay for public employee pension plans. It is somehow deemed acceptable for government to continue offering employees these ridiculous pension plans at the expense of the taxpayer. The public sector needs to follow the private sectors lead and phase them out with 401k plans. Cutting back my taxes by putting public employees in sensible, fair retirement plans is the best economic stimulus plan that I can think of.