What Happens to My Pension If My Company Files Chapter 11?

When a company faces severe financial distress, it may seek protection under Chapter 11 of the U.S. Bankruptcy Code. This legal process allows the business to reorganize its operations and debts, aiming to emerge as a viable entity rather than liquidating its assets entirely. For employees, a primary concern during such a period often revolves around the security of their retirement savings and pension plans. Understanding how different types of pension plans are structured and protected during a Chapter 11 bankruptcy filing is important for individuals to assess their financial outlook.

Understanding Pension Plan Structures

Retirement plans sponsored by employers generally fall into two main categories: defined benefit plans and defined contribution plans. These structures differ significantly in how contributions are made, who bears the investment risk, and how assets are held. The distinction between these types is fundamental to understanding their treatment in a bankruptcy scenario.

Defined benefit plans, often referred to as traditional pensions, promise employees a specific monthly payment upon retirement, typically based on a formula involving salary, years of service, or age. The employer is responsible for funding the plan and bears the investment risk, ensuring there are sufficient assets to pay future benefits. Employers are required to prefund these plans, though funding levels may vary, and assets are generally held in a trust that is intended to be separate from the company’s operating assets.

Defined contribution plans, such as 401(k)s, 403(b)s, and profit-sharing plans, operate differently. In these plans, contributions are made by the employee, the employer, or both, into individual accounts for each participant. The employee typically directs the investment of these funds and bears the investment risk, meaning the final retirement benefit depends on the investment performance of the account. Assets are legally required by federal law to be held in separate trusts, distinct from the company’s general business assets.

Protection for Defined Benefit Plans

Defined benefit plans receive a layer of federal protection through the Pension Benefit Guaranty Corporation (PBGC), an independent agency of the United States government. The PBGC’s mission is to protect the retirement incomes of over 31 million American workers and retirees in private-sector defined benefit pension plans. It achieves this by insuring the benefits of most traditional pension plans.

When a company files for Chapter 11 bankruptcy and can no longer maintain its defined benefit pension plan, especially if the plan is underfunded, the PBGC may step in. This occurs through a “distress termination” process, where the bankruptcy court determines that the employer cannot continue in business unless the pension plan is terminated. If the plan is terminated and does not have enough assets to pay promised benefits, the PBGC assumes responsibility for the plan.

The PBGC guarantees payment of vested benefits up to certain legal limits, but it does not always guarantee 100% of an individual’s promised pension benefit. The maximum guaranteed amount is adjusted annually and varies based on factors such as age at retirement and the form of the benefit. Benefits that exceed this statutory maximum, or certain types of benefits like unvested benefits or specific supplemental benefits, may not be fully covered by the PBGC.

The PBGC is funded primarily through premiums paid by the companies that sponsor defined benefit plans and through earnings on its investments. When the PBGC takes over a plan, it liquidates the plan’s assets and then uses those proceeds along with its own funds to pay benefits to participants. The process involves the PBGC becoming the trustee of the plan, managing its assets, and making benefit payments to eligible retirees and beneficiaries. While benefits earned prior to the bankruptcy are generally protected, any future benefit accruals may cease or be altered as part of the company’s reorganization plan.

Protection for Defined Contribution Plans

Defined contribution plans, such as 401(k)s, are more secure in a company bankruptcy than defined benefit plans due to their structure and federal regulations. The Employee Retirement Income Security Act of 1974 (ERISA) mandates that assets held in these plans must be kept separate from the employer’s operational assets. This separation means the funds are held in a trust or custodial account, legally distinct from the company itself.

Because these assets are held in a separate trust, they are protected from the company’s creditors even if the employer files for Chapter 11 bankruptcy. The bankruptcy court cannot seize these funds to pay off the company’s debts. This separation ensures that the retirement savings belong to the employees, not to the company or its creditors.

While the principal balance in a defined contribution plan is safeguarded, there can still be impacts. If a portion of an employee’s 401(k) was invested in company stock, and the company’s stock value declines significantly or becomes worthless due to bankruptcy, that specific investment will lose its value. This is a risk borne by the employee, as they direct the investments within their account.

During a Chapter 11 reorganization, an employer may reduce or suspend its matching contributions to defined contribution plans to conserve cash and facilitate its restructuring. While this does not affect the existing funds in an employee’s account, it can impact future savings growth. Additionally, there might be administrative changes, such as a change in the plan administrator or record-keeper, but these changes do not affect the security of the underlying assets.

Steps for Pension Holders During Chapter 11

When a company files for Chapter 11, pension holders should take proactive steps to understand the implications for their retirement benefits.

• First, identify the type of pension plan held (defined benefit or defined contribution), as this dictates applicable protections and processes.
• Locate your Summary Plan Description (SPD), which outlines plan rules, benefits, and contact information for the plan administrator.
• Monitor official communications from the company, the bankruptcy court, and the PBGC. These communications provide updates on bankruptcy proceedings, proposed changes to benefit plans, and instructions for participants. Companies are required to notify employees about significant plan changes or terminations, and these notices often contain important deadlines or actions required from participants.
• For those with defined contribution plans, understand your investment options and the status of employer contributions. If the plan is terminated, employees may roll over account balances into an Individual Retirement Account (IRA) or a new employer’s retirement plan to preserve tax-advantaged savings. Consult with a financial advisor to understand the tax implications and suitability of various rollover options.
• Participants in defined benefit plans should pay close attention to any announcements regarding plan termination or PBGC involvement. If the PBGC takes over a plan, individuals may need to contact the PBGC directly to confirm their benefit status and ensure proper payments are initiated. The PBGC provides continuity of payments, but understanding the guaranteed benefit limits is important.
• Consulting with a financial professional can provide tailored guidance on managing retirement assets during such uncertain times.