What Happens to Pension if Company Goes Bankrupt?

When a company faces financial distress, the security of employee pension benefits becomes a significant concern. This article explains how different pension plans are treated during bankruptcy and outlines the resources available to protect your retirement.

Distinguishing Pension Plan Types

Employer-sponsored retirement plans fall into two primary categories: defined benefit plans and defined contribution plans. The protections for retirement savings vary considerably based on the plan’s structure and how benefits are accrued, funded, and protected.

Defined benefit plans, often called traditional pension plans, promise a specific monthly payment at retirement. This payment depends on factors like an employee’s salary history and years of service. The employer bears the investment risk and is responsible for ensuring the plan has sufficient funds. These plans are company liabilities, meaning the employer is obligated to pay the promised benefits, and their security is tied to the company’s financial health.

In contrast, defined contribution plans (e.g., 401(k)s, 403(b)s, and 457 plans) involve contributions into individual investment accounts. The value of these accounts fluctuates based on investment performance, and the employee bears the investment risk. The money in these accounts belongs to the employee from the outset and is held in a trust separate from the company’s general assets.

Under the Employee Retirement Income Security Act of 1974 (ERISA), qualified defined contribution plan assets are held in trust, separate from the company’s operational assets. This makes them inaccessible to the company’s creditors in a bankruptcy proceeding. While the company’s bankruptcy might halt future contributions, the existing funds in these individual accounts are protected. Defined benefit plans, as company liabilities, rely on an external insurance mechanism for protection.

The Pension Benefit Guaranty Corporation

The Pension Benefit Guaranty Corporation (PBGC) is a federal agency established under ERISA to protect the retirement incomes of workers and retirees in private-sector defined benefit pension plans. It operates as an insurance program, providing a safety net if a plan becomes underfunded or terminates. The PBGC ensures basic pension benefits are paid even if a former employer cannot meet its obligations.

The PBGC steps in when a company’s defined benefit pension plan terminates due to financial distress, often during bankruptcy proceedings. This can happen through a distress termination (initiated by the company) or an involuntary termination (initiated by the PBGC). When the PBGC takes over, it assumes responsibility for the plan’s assets and liabilities, ensuring benefit payments up to statutory limits.

The PBGC guarantees basic pension benefits, including those at normal retirement age, most early retirement benefits, disability benefits, and survivor annuity benefits. However, there are limitations. Benefits unvested at termination, certain supplemental benefits, or benefit increases adopted within five years prior to termination are not guaranteed. Health and welfare benefits, severance pay, and vacation pay are also not covered by PBGC insurance.

The PBGC’s protection includes a maximum guaranteed benefit, adjusted annually. This limit depends on factors such as the participant’s age when benefits begin and the year the plan terminates. For single-employer plans, the maximum monthly guaranteed benefit for a participant retiring at age 65 is approximately $7,100. This amount is lower if benefits commence before age 65 and may be higher if they begin after age 65.

Individuals with very high pension entitlements might experience a reduction if their promised benefit exceeds the PBGC’s maximum guarantee. The PBGC also insures multiemployer plans, which are typically established through collective bargaining agreements. The guarantee limits for multiemployer plans are generally lower and determined differently than those for single-employer plans.

Navigating Your Pension After Company Bankruptcy

When a company files for bankruptcy, understanding the status of your pension is important. Gather all relevant information about your specific pension plan, including whether it is a defined benefit or defined contribution plan, and locate plan documents such as the Summary Plan Description. Confirm your vested benefits, as these are the benefits you have earned and are entitled to receive.

Contact the company’s human resources department or the plan administrator to ascertain the pension plan’s current status. This provides insight into whether the plan will continue, be terminated, or if a new administrator will take over. Maintain personal records of employment dates, compensation, and contributions, as this information may be necessary for future claims.

For individuals with defined benefit plans, monitor for PBGC involvement. If the PBGC takes over the plan, participants will be notified directly by the agency. Once the PBGC assumes trusteeship, it will review the plan’s records to determine individual benefit entitlements. If you are already receiving benefits, payments will generally continue at their normal amount during this review period.

Applying for benefits from the PBGC involves completing forms and providing documentation, available on the PBGC’s official website. The agency requires information to verify eligibility and calculate the guaranteed benefit amount. The process from plan termination to benefit payments can take several months, but the agency works to ensure uninterrupted payments once it assumes responsibility.

For defined contribution plans (e.g., 401(k)s), funds are held by a third-party custodian, like a financial institution, rather than the employer. This means the funds are protected from the employer’s bankruptcy creditors. Even if the company ceases operations, the money in the individual’s account remains accessible, though future contributions may stop.

Participants in defined contribution plans have several options for their funds. They can leave the funds with the former employer’s plan custodian, roll them over into a new employer’s plan (if permitted), or transfer them into an Individual Retirement Account (IRA). A direct rollover is recommended to avoid tax implications and withholding. If an indirect rollover occurs, funds must be deposited into a new qualified account within 60 days to avoid being treated as a taxable distribution and a potential 10% early withdrawal penalty if under age 59½. Consult the plan administrator or financial institution for specific procedures and options.