When you have significant funds in a 401(k) retirement account, it makes sense to wonder whether those assets are safe. Luckily, 401(k) accounts are protected by federal law in many scenarios.
Here’s how your 401(k) funds may be protected in common cases and which institutions do or do not offer coverage.
How your assets are covered in different scenarios
If you declare bankruptcy
Under federal law, all retirement plans covered by the Employee Retirement Income Security Act (ERISA) include an anti-alienation provision. This means, in general, assets in your 401(k) plan are fully protected from any creditor, even in bankruptcy.
There are several exemptions to this protection with the most common ones being:
In certain divorce cases, where payment to an alternate payee is required under a Qualified Domestic Relations Order.
IRS levy or judgment where the IRS can force a participant to take an allowed distribution from the plan. However, the IRS must follow the terms of the plan and, therefore, cannot force a distribution when you are not otherwise eligible to take one.
Criminal or civil judgments for plan-related crimes/activity.
When there has been a breach of fiduciary duty or criminal activity involving the plan.
One of the requirements for creditor protection is that the plan be covered by ERISA. The vast majority of Gusto 401(k) plans are covered.
401(k) plans that are “owner only” plans are not covered by ERISA and cannot take advantage of the ERISA creditor protection. An owner-only plan is one where the only individuals eligible to participate under the terms of the plan are the business owner and their spouse (if applicable). However, this does not mean that “owner only” 401(k) plan assets are fully exposed to creditors; instead protection will be determined under the state laws applicable to that plan. Note that while “owner only” is the most common generic term and the IRS sometimes uses the term “one-participant 401(k) plan”, these plans are often referred to using different trademarked names such as Solo(k), Individual(k), I(k), Indy(k), and uni(k).
If your employer goes out of business or declares bankruptcy
Under federal law, all retirement plans covered by ERISA must deposit all assets of the plan in a trust with the assets held in either a bank or other organization authorized by the IRS to hold plan assets. If the employer sponsoring your 401(k) plan either goes out of business or declares bankruptcy, any assets that have been deposited into the plan’s trust will be fully protected. Neither your employer nor their creditors have the right, or ability, to take your assets from the plan’s trust account.
However, it’s important to note that you may not be able to take a distribution (even if you are eligible for one) for a period of time while Gusto either works with your plan sponsor to terminate the plan or, if necessary, the Department of Labor if your plan sponsor is unresponsive.
The only exception to this protection is for any contributions from you or your employer that were not deposited into the plan’s trust before your employer declared bankruptcy. If there are amounts due, the plan will be listed as one of the creditors owed payment through the bankruptcy proceeding. Whether these amounts will eventually be deposited into the plan’s trust will depend on the assets your employer has to repay creditors and the priority of the creditors that may be paid before the plan. At this time, employee contributions withheld from your pay but not submitted to the plan are not considered unpaid salary and are lumped together with all other creditors under bankruptcy law.
If Gusto goes out of business or declares bankruptcy
While Gusto expects to be in business indefinitely, no one can predict the future. If, for some reason, Gusto must wind down its business, we will work with your employer to transfer the plan to another qualified service provider.
In the unlikely scenario that Gusto does not have an opportunity to transfer your plan, plan assets funds will continue to be held by the plan’s custodian. For accounts held at Benefits Trust Company (BTC) - a third-party service provider, BTC acts as custodian for the assets held in such accounts. For accounts held at Gusto Brokerage, LLC (Gusto Brokerage) - an affiliated broker-dealer registered with the Securities and Exchange Commission and a member of the Financial Industry Regulatory Authority, Inc. (FINRA) and the Securities Investor Protection Corporation (SIPC), Gusto Brokerage acts as custodian for the assets held in such accounts. For Individual Retirement Accounts (IRAs), Forge Trust Co., a third-party service provider, acts as IRA custodian and the IRA assets are held in a Gusto Brokerage brokerage account.
If assets are mismanaged by Gusto or the plan sponsor
In addition to the processes, procedures, and safeguards Gusto has in place to protect all plan assets, we carry an ERISA fidelity bond that protects all ERISA plan assets under Gusto’s control from certain fraudulent or dishonest acts by Gusto or its employees. In addition, your plan sponsor may also have coverage that protects plan assets from negligent actions by them or their employees.
Which institutions cover employer plan assets?
Pension Benefit Guaranty Corporation (PBGC)
The Pension Benefit Guaranty Corporation is a quasi-governmental organization that provides insurance for pension plan assets. Covered plans pay insurance premiums to the PBGC, so it is operated outside of the normal federal governmental budget process. However, the PBGC only covers traditional pension plans, such as defined benefit plans. This means that your Gusto 401(k) plan is not covered by the PBGC.
Other types of coverage
Federal Deposit Insurance Corporation (FDIC)
The Federal Deposit Insurance Corporation, commonly known as the FDIC provides insurance for customers of depository institutions, such as banks. While FDIC insurance will protect cash and some types of cash equivalent accounts, securities, including stocks, bonds, and mutual funds are not protected by the FDIC. 401(k) plan cash, the assets in your 401(k) account that are held in cash or a money-market deposit accounts at a bank may be eligible for FDIC “pass-through” insurance. If applicable regulatory requirements are satisfied, each 401(k) plan participant’s non-contingent interest in such deposits is separately insured, up to the current maximum limit of $250,000 per participant.
Securities Investor Protection Corporation (SIPC)
SIPC insurance protects customers of SIPC-member broker-dealers - such as Gusto Brokerage - against the loss of cash and securities if the SIPC-member firm fails. SIPC protection does not apply to assets held at non-broker-dealer custodians (e.g. BTC). SIPC protection only covers Gusto Brokerage’s custody function — restoring customers’ securities and cash that are in their brokerage accounts — in the event of Gusto Brokerage’s liquidation. If your 401(k) account’s assets are held at Gusto Brokerage, rather than BTC, the assets should be covered by SIPC protection up to the current maximum of $500,000, which includes a $250,000 limit for cash.
Note: FDIC and SIPC protect against a bank’s or brokerage firm’s failure including assets that go missing due to the firm’s own fraud or theft but they do not cover investment losses, bad investment advice, or fraud committed by a third-party.