Think 401(k) Plans Provide More Security Against Employer Failures? Think Again

Most people think that they are in better shape having a 401(k) plan as opposed to a traditional defined benefit pension plan when their company files for bankruptcy or goes out of business. 

The reason is quite simple: whereas employers are responsible for making sure the funds are there when the employee retires under a defined benefit plan, defined contribution plans like 401(k) plans are an employee's responsibility once an employer makes the appropriate pension contribution to the employee's individual account.  Thereafter, the funds (with the exception of matching contributions which take time to vest) belong immediately to the employee. Hence, there is insurance provided by the government through the Pension Benefit Guaranty Corporation (PBGC) for defined benefit plan terminations, but no such insurance for defined contribution plans.

Thus, it has been roundly assumed that since 401(k) plan participants own their pension accounts from the start, employees with 401(k) plans have to less worry about when their employer goes under.

Yet, this is not necessarily so.  Robert Matthews of the Wall Street Journal explains the potential difficulties for 401(k) participants when their company becomes defunct:

Participants in 401(k) plans are protected from their employer's failure because they actually own the assets in their accounts - unlike employees with traditional pension plans, such as the one run by United Airlines, which the government took control of late last year. That means they can get access to their funds or take them along when they leave their job.

But a growing number of individuals who had 401(k)s through small companies that are now defunct find that getting control of their money can take years. By statute, if there's no one from the former employer authorized to approve a rollover, the financial-services company that manages the plan cannot release the money - which means it can take intensive sleuthing and a lot of patience to recover it.

Thankfully,

Recognizing the problem, the Labor Department is about to propose new rules that could make the process easier and quicker. The rules, which the department plans to unveil this spring and hopes put into effect by year end, would authorize financial institutions to release the money to workers in such situations.

Given the increased number of employees with 401(k) plans at smaller companies, which have a higher likelihood of going belly up, this initiative by the Labor Department is certainly a welcome development and will hopefully go along way in giving 401(k) participants quicker access to their pension funds when these scenarios arise.

PS