What Happens to Your 401(k) Plan If Your Company Goes Bankrupt?

Wooden block with the number 401K with some money around.
Marvin Samuel Tolentino Pineda / Getty Images/iStockphoto

If the company you work for goes bankrupt, you’ll most certainly have a lot on your mind — starting with finding a new job. What may not immediately come to mind is what happens to your 401(k) plan, which may hold your life’s savings.

The good news is that you don’t need to panic: That money won’t vanish in the bankruptcy. But there are some additional details you should know in the unlikely and unfortunate event this ever happens to you.

Most Important To Know: You Are Protected

First things first: If your company goes bankrupt, your 401(k) assets are protected. This is because all 401(k) plan money must be kept in a trust that is separate from a company’s general assets. This means that under no circumstances can either your company or its creditors take your funds, thanks to the Employee Retirement Income Security Act (ERISA).

There Are Two Primary Forms of Bankruptcy

Companies can file for two types of bankruptcy. Under Chapter 11, a company “reorganizes,” meaning it continues to function while it sorts out its financial affairs with creditors, often getting additional funding or concessions along the way. If your company files Chapter 11 bankruptcy, you might not notice any changes at all in your 401(k) plan. Your company simply will continue to keep operating until it ultimately emerges from bankruptcy.

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A Chapter 7 bankruptcy, on the other hand, is a complete liquidation. All of the company assets will be sold, with the proceeds used to pay off creditors. However, even in this bleakest of scenarios, your 401(k) money is segregated and cannot be taken.

You Might Lose Deposits in Transit

There is one specific scenario in which you may possibly lose some of your 401(k) money in the event of an employer bankruptcy. By law, employers must deposit employee 401(k) contributions to the plan trust account within a certain time period. Depending on the size of the employer, this could be either seven or 15 business days after the end of the contribution month.

In this case, the money that is in transit but not yet in the 401(k) trust account may potentially be lost, as it’s technically still in the company’s general account. 

Employer Contributions Must Be Vested

When your employer makes contributions to your 401(k) plan, they are typically subject to a vesting schedule. For example, you may not have any access to that money for three full years, or it may vest in 20% increments over a period of five years. Whatever the case, any employer contributions to your 401(k) plan that have not yet vested may be lost.

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Common Option: Merged With Another Company

In many cases, a company that goes bankrupt either has its assets purchased or is simply taken over by a separate company. In that case, your 401(k) plan likely will be merged with the plan of the new company.

Some of the details of your plan may change, from vesting schedules to employer contributions to the investments you can choose from, but your assets will be safe and sound in the new plan. Whether or not you can maintain your account at the new firm, however, may depend on whether you are retained as an employee. 

Alternate Option: Roll Over to an IRA

In many cases, 401(k) plan participants will have to roll over their money to an IRA in the case of an employer bankruptcy. For example, if no new company takes over the bankrupt firm, or if there is an acquiring firm but you’re not hired on as an employee, you’ll have no place to keep your 401(k) assets.

Although distribution is technically an option, it’s a terrible one for your long-term future, and you’ll have to pay income taxes on the withdrawal. If you’re under age 59½, you’ll also face a 10% early withdrawal penalty. But if you roll your money over to an IRA, it’s a tax-free transaction that maintains the tax-deferred benefits of your original 401(k) plan. 

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Note About Company Stock

One of the unfortunate truths is that many Americans keep a large percentage of their 401(k) assets in company stock. While this may seem great if the company is booming, in the event of a bankruptcy, you may pay the price twice.

First, you may lose your job, and second, the company stock in your 401(k) plan may become worthless. For this reason — and a host of others — the Financial Industry Regulatory Authority put out a warning to investors about keeping too large of an allocation of company stock in a 401(k) plan.

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