Contribution Plan Failure: Options for Participants
Frank Armstrong III
JULY - 2006 - If
an employer fails, or terminates a defined benefit plan, participants
may find themselves facing significant shortfalls. Absent
outright fraud or theft, however, the failure of a defined
contribution sponsor is not usually as troublesome.
that the required contributions were made on schedule, a
defined contribution plan can never be underfunded. Unlike
a defined benefit plan, an employer does not promise a particular
benefit. While an employer must petition the Department
of Labor (DOL) for a plan termination, the procedure is
relatively simple compared to a defined benefit plan. All
funds in an employee’s account will immediately become
vested upon plan termination and eventually will be paid
out to each employee.
a 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 are made to the participants. There
are, however, unfortunate exceptions.
a few cases, companies may not have made required contributions
to their plans, or may have actually stolen from the plans.
The following warning signs are extracted from the DOL website
The 401(k) or individual account statement is consistently
late or comes at irregular intervals.
The account balance is inaccurate.
The employer failed to transmit contributions to the plan
on a timely basis.
is a significant drop in account balance that cannot be
explained by normal market ups and downs.
The 401(k) or individual account statement shows that
contributions from paychecks were not made.
Investments listed on the statement are not what was authorized.
Former employees are having trouble getting their benefits
paid on time or in the correct amounts.
Unusual transactions have occurred, such as a loan to
the employer, to a corporate officer, or to one of the
There are frequent and unexplained changes in investment
managers or consultants.
The employer has recently experienced severe financial
if a plan possesses illiquid investments, such as real estate
or limited partnerships, payout may be delayed until the
properties can be unwound. For example, the Eastern Pilots
pension plan had cleverly invested over 90% of the fund
in raw undeveloped land. It took over 10 years for the participants
of the Air Line Pilots Association 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 they had expected. Fortunately, these gross
lapses in fiduciary responsibility are rare.
provided a stark lesson in the importance of avoiding company
stock in a retirement plan. Many Enron employees lost their
jobs and their 401(k)s at the same time. Wherever possible,
participants should reduce the holdings of employer stock
in personal accounts and retirement plans to zero.
many company plans hold accounts for former employees, some
of these accounts may become “orphans” over
time. If a plan terminates and those ex-employees cannot
be found, their accounts will likely be liquidated and rolled
into an IRA with a third party. The default investment will
most likely be cash. Surprisingly, there are many orphan
accounts nationwide. Employees should keep their former
employers notified of their current address. If the option
is provided by a former employer, the account balance should
be rolled over into an account that the former employee
rare cases, the liquidation of a company leaves the pension
plan itself orphaned, with no entity responsible for winding
up its affairs or making distributions. In such an event,
the DOL would appoint an independent third-party trustee
to terminate the plan.
a plan terminates, the best option for most individuals
is to immediately roll over the account into an IRA and
invest it for future needs. A rollover often allows one
to reduce costs, tailor the account to individual circumstances,
and upgrade investment choices. Other options may be available,
but most participants will benefit from keeping the money
in a tax-deferred IRA.
Armstrong III is the founder and principal of Investor
Solutions, Inc. (www.investorsolutions.com),
a fee-only, SEC-registered investment advisor. He is also
the author of The Informed Investor: A Hype-Free Guide
to Constructing a Sound Financial Portfolio (Amacom).