What happens with pension after company bankruptcy?

If you work for a company that has a pension, should you be worried?

What protections do you have?

Will all the money you have been paying into your retirement just be gone?

Recently, American Airlines filed for Chapter 11 bankruptcy leaving many wondering “What happens to their pension?“.

Whether you’re an employee of theirs or any other company that offers a pension, here’s what you need to know.

Insurance On Your Pension Plan

Fortunately, it is not as bad as most people think…maybe.  There are safeguards in the United States to prevent you from losing your pension plan. 

In the United States every defined-benefit retirement plan is insured, at least to a point.  Most will receive all or at least most of their company pension even if your company goes bankrupt.  However, in some cases,  it may not be every penny you expected.

Also be sure to check out my article on, “Should I Roll My Pension Into an IRA” for some options on your pension plan.

What Happens When a Company Goes Bankrupt?

When a company goes bankrupt they have two choices.  They can reorganize and try to stay in business by reducing costs and attracting new investors, or they can liquidate.  The pension plan is usually terminated in reorganization and always terminated in liquidation.  So, then what happens?  A federal insurance agency called the Pension Benefit Guaranty Corporation (pbgc.gov), takes over the pension payments. Here’s some information on the PBCG taken from their site:

The PBGC is a federal corporation created under the Employee Retirement Income Security Act of 1974. It currently guarantees payment of basic pension benefits earned by 44 million American workers and retirees participating in over 29,000 private-sector defined benefit pension plans. The agency receives no funds from general tax revenues. Operations are financed largely by insurance premiums paid by companies that sponsor pension plans and by investment returns.

Only employees with the largest pensions actually take a hit.  The Pension Benefit Guaranty Corporation maximum annual payment, which rises with inflation, is $54,000 this year for workers who retire at age 65.  As with any insurer, the PBGC has some restrictions.  For example, it prorates recent pension increases.

However, in all, 84 percent of retirees get their full pension even after bankruptcy.

A Few Rare Cases Under Reorganization

In a few rare cases of a company bankruptcy reorganization, the employer maintains the its pension plan.  That normally only happens for one of three reasons.

1. The benefit is low
2. Employee turnover is high
3. The pension plan is new

Avoiding Bankruptcy is Better For The Company

In most cases, however, it is always better for the company to avoid bankruptcy altogether.  In December of last year, Congress gave some help in this direction by relaxing the 2006 Pension Protection Act’s strict rules governing pension funding.  As counter intuitive as it may seem, this is one move that endangered workers should embrace.

As a result of this move, according to Dallas Salisbury, president of the non-partisan Employee Benefit Research Institute, ” Given the economic downturn, employees are better off than if the company was forced to make a large pension contribution”.  “It’s better to stay in business than make a pension contribution”.

American Airlines Pension

In American Airline’s case they are filing for Chapter 11 bankruptcy protection.  In this case the PBGC may need to step in and assist with their pension obligations.

The Pension Benefit Guaranty Corp., created to protect private retirement benefits, may be unable to cover the loss because Congress has limited the size of pensions it can pay, Director Josh Gotbaum said today in a statement.

“Unfortunately, when the agency assumed airline plans in the past, many people’s pensions were cut, in some cases dramatically,” Gotbaum said in the statement. The PBGC will encourage American to “fix its financial problems” and keep its pensions intact, he said.

In the meantime, AMR employees seem to be protected.   But a quick look at the numbers doesn’t seem to reassuring.

Recent numbers show that they have about $8.3 billion in assets to cover the $18.5 billion in pension liabilities.  If AMR has no choice and has to terminate the plan, that would leave the PBGC on the hook for a cool $17 billion.

Chump change for the PBGC, right?  Don’t be so sure……

Strength of the Pension Benefit Guaranty Corporation

Just like the FDIC, the financial strength of the PBGC hardly ever gets questioned.   Unfortunately, these are unique times and it seems that no entity is out of harms way.  Lowering interest rates and rising corporate defaults has led to a $33.5 billion deficit in the first quarter of 2009 for the PBGC.  This is the largest deficit for the 35 year old agency which is an increase from the $11 billion deficit ending fiscal year 2008.  Acting director Vince Snowbarger says,

“The PBGC has sufficient funds to meet its benefit obligations for many years because benefits are paid monthly over the lifetimes of beneficiaries, not as lump sums. Nevertheless, over the long term, the deficit must be addressed.”

The Deficit Continues

For 2011, the PBGC just encountered it’s largest deficit while insuring 1 out of every 7 Americans.

The Pension Benefit Guaranty Corp. was quoted as saying it ran a $26 billion imbalance for the budget year that ended Sept. 30.

Their pension obligations rose by $4.5 billion as they currently insure over 44 million Americans.

Does it make you nervous?  It would me.

How Does This Affect You?

If your company files for bankruptcy or you fear that it will, I would contact the PBGC and talk to them directly.  Be sure to visit their website frequently and check for updates.  You are basically in their hands and you have limited choices.

If you have the option, consider rolling your pension into an IRA to get it out of your company’s hands.  I’ve had many clients do this so that they never had to worry about this.  Be sure to consult a financial planner and/or tax advisor before implementing this step.