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Submitted by: Frank Armstrong
Frank Armstrong, is President and founder of Investor Solutions, Inc. He is a pioneer in integrating academically driven portfolio management techniques with institutional best practices for individual investors around the world. Frank has over 30 years experience in the securities and financial services industry. He holds a B.A. in Economics from the University of Virginia and is a CERTIFIED FINANCIAL PLANNER® practitioner.
If you are a participant in a defined benefit plan, and your employer fails or terminates the plan, it can ruin your whole day. (See DB Plan Termination) However, absent outright fraud or theft, the failure of a defined contribution sponsor is not usually nearly so traumatic.
Assuming that the required contributions were made on schedule, a defined contribution plan can never be underfunded. Unlike a defined benefit plan, the employer is not promising any particular benefit. While the employer must petition the Department of Labor for a plan termination, the procedure is relatively simple compared to a Defined Benefit plan. No actuarial calculations are required, and government processing is usually not delayed unreasonably. Whatever funds are in your account will become immediately vested upon plan termination and eventually paid out to you.
If your plan is invested in liquid securities such as mutual funds or separately managed accounts, payout should be fairly straightforward. The accounts are valued as of a termination date and distributions made to the participants. That’s the normal course of events. But there are a limited number of unfortunate exceptions.
In a few cases companies may not have made required contributions to their plans, or actually stolen from them. While unusual, it’s not impossible. The following warning signs are extracted from the Department of Labor web site article:
1. Your 401(k) or individual account statement is consistently late or comes at irregular intervals
2. Your account balance does not appear to be accurate
3. Your employer failed to transmit your contribution to the plan on a timely basis
4. A significant drop in account balance that cannot be explained by normal market ups and downs
5. 401(k) or individual account statement shows your contribution from your paycheck was not made
6. Investments listed on your statement are not what you authorized
7. Former employees are having trouble getting their benefits paid on time or in the correct amounts
8. Unusual transactions, such as a loan to the employer, a corporate officer, or one of the plan trustees
9. Frequent and unexplained changes in investment managers or consultants
10. Your employer has recently experienced severe financial difficulty.
Unfortunately, if there are illiquid investments such as real estate, or limited partnerships, payout may be delayed until the properties can be unwound. This was the case with the Eastern Pilots Pension Plan where the Air Line Pilots Association had cleverly invested over 90% of the fund in raw undeveloped land. In that sorry case it took over 10 years for the participants to be paid out and the plan terminated. Even worse, the land had been systematically overvalued by the trustees, so the pilots never recovered the full amount that they had been led to expect. Fortunately, these gross lapses in fiduciary responsibility are rare.
The Enron example provided a stark lesson in the importance of avoiding company stock in your retirement plan. Losing your job and having your 401(k) crater at the same time is the financial equivalent of the perfect storm. It’s a disaster that you may never recover from. To the extent that Enron employees chose that investment over a diversified account within the plan it was self induced injury. Wherever possible, reduce your holdings of employer stock in your personal accounts and retirement plans to zero.
Because many company plans hold accounts for past employees, over time some of these accounts become “orphans”. If a plan terminates and those orphans cannot be found, they are likely to have their accounts liquidated and rolled into an IRA with a third party. The default investment will most likely be cash which is hardly ever optional. Strange as it may sound there are many orphan accounts nationwide. The lesson here is to keep your former employers notified as to your current address. If the plan gives you the option, a rollover into an account you control might be your best course.
In a very few rare cases the liquidation of a company leaves the pension plan an orphan with nobody to wind up its affairs or make distributions. In that event, the Department of Labor will appoint a third party independent trustee to terminate the plan.
In most cases when a plan terminates your best option is to immediately roll over the account to an IRA and invest it for your future needs. A rollover often allows you to reduce costs, exactly tailor the account to your situation, and upgrade investment choices. However there are other options you may need to consider. See our series on Changing Jobs in the Retirement Planning Section of our Learning Center.
The worst thing you can do is to take the money and blow it on a vacation or new car. The tax penalty will be devastating. But, more importantly, systematically looting your own retirement account destroys your future security. Keeping the money at work, or putting it back to work as soon as possible in a tax favored environment is your very best choice – unless, of course, you prefer to eat dog food during your retirement.
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Authored by the
founder of the
PaladinRegistry