401k Safety in Bankruptcy

[Guest Eric_2002]

Outside of stock, which would obviously not be worth much, how safe are the other investments in a 401k? For example, say I have 4 mutual funds, that my money is equally distributed. If my company goes bankrupt, are the mutual fund monies protected? If so, where can I find the legal documentation stating so? If it is not protected, then the option is to roll the 401K money out of the company plan and into IRA's?

[Guest JEP]

generally, under the anti-alienation rules, as long as the money is in a qualified plan it is safe from creditors. Unless of course you are the trustee and are involved in some wrong doing that has caused the bankruptcy. However, for most participants, the money is safe in the qualified plan, even from creditors of the employer. The employer is unable to get to this money as well are the creditors of the employer.

[Guest jvanheyde]

I assume you are focusing on the safety of your own plan account in a qualified plan (such as a 401(k) PSP).

The Plan/Trust is separate and apart from the sponsoring employer, so if the employer goes bankrupt, the plan's investments are not impacted, except to the extent the plan's assets included employer securities (which was the case for many participants in Enron). In this scenerio, your account balance is not impacted by the bankruptcy unless you have invested in the employer's stock inside your plan account.

If you are concerned about your ERISA qualified plan account and your personal bankruptcy, look at the 1992 US Supreme Court Case of Patterson v. Shumate. It holds that ERISA's anti-alienation provision causes the plan account to be excepted out of the bankruptcy estate - meaning, creditors cannot grab it. Additional protection may be available under state law. For instance, in Florida, IRAs and account balances in 401(a) plans are exempt from the claims of creditors. I recall it is, or is around, Section 222.21 Fla. Stat.

[Kirk Maldonado]

I seem to recall that if you are a self-employed person, your retirement plan only has a limited exemption under California's bankruptcy provisions. I think that the exemption is limited to the amount necessary to support the person.

[Guest whatsup]

On a related note, if an employer has not been funding 401(k)matching payments for some time (12+ months) and then goes Ch. 11, what are the chances of the plan beneficiaries ever getting these unfunded employer matching contributions? What status (secured, unsecured, etc.) do these unfunded contributions have in bankruptcy? Thanks.

[mbozek]

W: The plan would be a general creditor of the employer for the contibutions and would probably collect less than 10 cents on the dollar if the company is liquidated. If the company goes into ch 11 and continues after a reorganizaton it the plan has a better chance of revovering the contributions.

There are two ways in which plan participants can lose plans assets outside of a bankruptcy of the employer. First if the plan fiduciary uses plan assets as collateral for a margin loan the plan assets can be seized for a margin call by the lender. Second the assets of a plan can be seized by a trustee who is not a fiduciary of the plan to pay debts that the plan sponsor owes the trustee as a creditor of the sponsor if the loan documents permit such seizure.

[Kirk Maldonado]

MBozrk:

I disagree with your second conclusion. An employer cannot pledge the assets of a plan as collateral for a loan that the employer enters into.

[mbozek]

Kirk: You misnunderstand the nature of the arrangement. It is my recollection that the facts are as follows: The employer takes out a loan for its busisness and the credit agreement allows the creditor to seize all accounts maintained by the employer at the bank. The bank/creditor is also the directed trustee of a qualified plan maintained by the employer as plan sponsor. When the employer defaults on the payment of the loan to the bank, the bank seizes the plan assets to satisfy the debt. According to a case I read the bank can seize plan assets. I think the name of the case is O'toole v. Arlington Trust Co, 681 F2d 94. I have also seen similar situations in financial institutions which seize a clients IRA to recover a margin loan on a personal account where the margin agreement allows for such seizure.

[Kirk Maldonado]

MBozek:

I haven't read that case, but if that is what it holds, it is just wrong. The plan's assets are not the assets of the employer.

[mbozek]

Kirk: Why dont we both read the case on Monday and respond. Again I have seen the same situation in IRAs being seized by the custodian to repay margin loans in personal accounts. Is the only difference that IRA assets are not held in trust by a fiduciary subject to the exclusive benefit rule?

[GBurns]

The original post was regarding an employee's 401(k) and the sponsoring employer's bankruptcy.

The contributed (credited) assets are in a custodial account in the employee's name and cannot and could not be used by the employer in any form or manner. the account is not held or maintained by the employer and so could not be an item in the possession of the employer. In any case possession does not transfer ownership and it still would not be subject to seizure.

The only attachments that have been possible are those created by the employee himself on his own behalf.

[Kirk Maldonado]

MBozek:

I read the case, and it does stand for the proposition that you cite it for.

Also, IRAs are a completely different situation than tax-qualified retirement plans.

[mbozek]

But there is consistency in result for both types of plans: The IRA assets of the owner/fiduciary can be seized by a custodian /non discretionary trustee to pay an unrelated debt of the owner to the custodian/trustee. Under OToole the assets of a qualified plan sponsored by an employer/fiduciary can be seized by a custodian/non discretionary trustee to pay an unrelated debt of the employer to the trustee. The rule seems to be that a nonfiduciary can seize retirement plan assets held by the nonfiduciary to pay a debt owed by the owner/sponsor of the plan to the nonfiduciary.

[Mike Preston]

If O'Toole stands for such, it then probably also stands for the premise that the Trustees that put plan assets within the reach of such creditors are probably violating their fiduciary duties.

[mbozek]

YUP __ that is why all documents pertaining to commerical loans should be reviewed by competent counsel and ERSA counsel to determine if there are such provisions. The only way to avoid such a problem is to keep commerical and benefits activities at separate financial institutions -- but this is at cross purposes with doing all commerical banking with one institution to build up a relationship.

[Guest Tom Geer]

IRAs are, of course, not qualified plans, and don't have the benefit of the anti-alienation rules. IR Annuities may be exmpt under state insurance law. I'll be interested in the O'Toole analysis, since I can't find it on the Web (being telecomm-challenged).

[mbozek]

No but IRAs are subject to state laws which protect the assets from the claims of the owner's creditors ( NY, NJ)- However, some custodians claim that this protection is waived pursuant to the terms of a margin agreement.

Also I found a NY state law case which contradicts OToole - Seidman v. Merchants Bank of NY, 2nd Dept AD 9/7/95 (no offical cite)