Fallout from Detroit’s bankruptcy: Get ready to field questions about your company’s retirement benefits

Article courtesy of SBAM Approved Partner ASE

By Michael J. Burns

A lot of the press coverage on the City of Detroit’s bankruptcy (Chapter 9) has focused on the real possibility that the city’s retirees will lose some or all of their pensions. The federal Employee Retirement Income Security Act (ERISA) does not cover public pensions, therefore the protections private employers have with their pensions does not apply to public pensions.  Although Michigan is one of nine states that protects public employee pensions, the State of Michigan did not guarantee the funding of the plans, and it is a real possibility that the public employees could lose their pension.  Of the $18 billion in debt that is strangling Detroit, $9.2 billion is in public pension and retiree healthcare.

With the media focus on the City’s retirement programs, private employers should be prepared to field employee (and spouse) questions about the security of their retirement programs.

ASE’s 2013 Michigan Policies and Benefits Survey reports that today over 92 percent of employers offer defined contribution plans (401k, 403b or 457 plan) to their employees. Only 16 percent or fewer also offer, or only offer, defined benefit plans.

If an employer offering a defined contribution plan goes bankrupt, what happens to the plan and the participant’s money? Whether the bankruptcy is a Chapter 7 (liquidation of the business) or Chapter 11 or 13 (reorganization), employees will be concerned about two issues: 1) How can they access their benefits? and 2) Will the benefits be secure going forward?

Generally, ERISA protects participants’ retirement plan assets from the bankrupt private employer’s creditors by requiring the assets be kept separate from the employer’s assets and held in trust or invested in insurance.

Importantly, ERISA preempts any state laws regarding private employee pension and welfare plans.

ERISA requires that the parties administering the pension plan (the fiduciaries) act solely in the interest of the plan participants and beneficiaries, and it makes these fiduciaries personally liable to restore plan losses made through the improper use of assets.

The U.S. Department of Labor’s Fact Sheet on protection of welfare and retirement benefits states that pension assets should not be at risk when a business declares bankruptcy. This is because ERISA requires that promised pension benefits be adequately funded and that pension monies be kept separate from an employer’s business assets and held in trust or invested in an insurance contract. Thus, if the employer declares bankruptcy, the retirement funds should be secure from the company’s creditors.

In addition, plan fiduciaries must comply with the ERISA provisions that prohibit the mismanagement and abuse of plan assets. If contributions to a plan have been withheld from employees’ pay, employees may be advised that they will want to confirm that the amounts deducted have been forwarded to the plan’s trust or insurance contract.

Further traditional single-employer defined benefit retirement plans and in a separate program, multi-employer (group union plans) are also protected by the Pension Benefit Guaranty Corporation (PBGC), a Federal Government corporation. If a plan is terminated because an employer has financial difficulty and cannot fund the plan, and the plan does not have enough money to pay the promised benefits, the PBGC will assume responsibility for the plan. The PBGC pays benefits after termination up to a certain maximum guaranteed amount.

On the other hand, defined contribution plans, such as 401(k) plans, are not insured by the PBGC.

In the event that a defined contribution pension plan is terminated, the plan must vest the accrued benefit 100 percent. This means that the plan owes all the pension benefits that were earned to date.

The DOL publishes a fact sheet on the impact of bankruptcy on both welfare and retirement benefits. Click here for the fact sheet.