What happens if your employer goes bankrupt?

• Position: Retirement Plans

World Com. Enron. Global Crossing. Kmart. Joe Smith's Tool & Dye Company. As many employees have become painfully aware, virtually any company, large or small, can go bankrupt. The loss of jobs is obvious. Yet, what happens to your company-sponsored retirement plan? Is your nest egg safe from the company's creditors?

The answer in part will depend on what type of bankruptcy the company files. Under Chapter 11, which is more common, it stays open and reorganizes financially. In such cases, many employees will continue to work and the retirement plan probably will continue, though the employer may reduce or eliminate matching contributions it was making before, or perhaps modify the plan's proviso. Filing Chapter 7 is far more serious. Here, the firm shuts down and any company-sponsored retirement plans are terminated.

Fortunately for employees, for the most part, their retirement rights and assets are protected under the Employee Retirement Income Security Act. ERISA, which applies only to private employers, requires that any retirement plan assets, whether under a traditional pension one or a defined-contribution plan such as a 401(k), be held in trust, separate from corporate assets and thus secure from company creditors. However, that doesn't always mean you won't lose some retirement funds.

Traditional pension plans, under which an employer agrees to pay out a defined benefit upon retirement, are Federally insured. Thus, if your employer goes belly up and the pension plan is underfunded, the Federal Pension Benefit Guaranty Corporation will step in to pay benefits. The catch is, it pays only up to a maximum limit. In 2002, that limit for workers retiring at age 65 is approximately $3,580 a month, or $42,955 a year. Although most employees will get full benefits under these maximums, higher-paid employees or workers with generous union-negotiated plans may not receive all that was promised.

The Federal government does not insure defined-contribution plans such as 401(k)s. ERISA requires plan assets to be held in trust and thus protected from creditor claims, but that still leaves room for losses. For example, your account's assets are not protected against decline in investment value, as employees of World Com, Enron, Kmart, and other firms holding large amounts of company stock in their plans painfully learned.

You also may lose some retirement benefits in the event that your plan contributions and any employer...