Building up a solid 401(k) plan can be a lot of work. So when you finally get things right, you naturally want to protect your investment, and the question of whether or not you might end up losing it will likely cross your mind now and then. And while some of those fears are unjustified, your 401(k) isn’t 100% safe — if that is the case, in what scenarios can you lose a part or all of your 401(k)?
All/part of your 401(k) might go away if the market crashes or the company you work for liquidates. You might also lose all/part of your 401(k) plan in a divorce settlement. However, this depends on the laws in your state and whether it qualifies as marital property.
Read on to learn how safe your 401(k) is and the factors/situations that might cause you to lose some/all of it.
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Is 401(k) Safe?
Generally, 401(k) is safe. However, despite having evolved dramatically in structure and features over the past 25 years, 401(k) is not immune to risk. Some of these risks have to do with your account management, while others are born out of market factors.
Since every 401(k) plan is run differently, I’m not going to explore the risks associated with the management. Instead, I’ll focus on the specific situations and factors that might cause you to lose part or the whole of your 401(k).
These are as follows:
- A stock market crash
- Employer liquidation, mergers, and acquisitions
- A divorce settlement
Let’s discuss each factor/situation in greater detail in the next section.
3 Ways You Can Lose Your 401(k) Money
A Stock Market Crash Can Impact Your 401(k)
A stock market crash might seem unlikely, given the last one happened over a decade ago, but it can impact your 401(k) if it happens. Since 401(k) plans are typically long-term, it’s a potential eventuality that might cause you to lose your entire plan or a significant chunk of it.
Whether you lose all or a fraction of your 401(k) in a market crash depends on your investment decisions.
To clarify this statement, let’s look at two hypothetical scenarios, A and B:
- Scenario A. In scenario A, you’ve invested all of your 401(k) in different stocks, perhaps in an attempt to diversify; if the market crashes, you’ll likely lose all your retirement savings despite being invested in stocks from different industries — why? Because a stock market crash cuts across industries, and shares typically lose value in such situations.
- Scenario B. You’ve split your investment 50-50 between stocks and bonds. If a market crash occurs, you’ll only lose 50% of your 401(k); the other half of your portfolio will likely remain intact or even experience a slight increase in value because bonds typically go up when stocks go down.
As you can see, you might end up losing some or all of your 401(k) savings to a stock market crash, depending on your investment decisions. However, that doesn’t necessarily mean that you should rush to rid your 401(k) plan of all stock when the market crashes.
Historically, stock markets aren’t known to stay down forever after a crash. They always bounce back, and whether you benefit or lose from the crash depends on your decisions.
For instance, you can opt to purchase more (carefully selected) stocks during this period and benefit later. The rationale is that as the stock market plunges, most people will rush to dispose of their equities. This will drive the share prices down, and you can capitalize on that to purchase more shares and hold out for a profit when the market recovers.
Employer Liquidation Will Terminate Your 401(k)
Your 401(k) will be terminated if the company you work for goes out of business. And while you might not lose all of your 401(k) contributions, you might end up parting with a significant amount depending on:
- The timing of the liquidation
- Your employer’s policy on matching/profit-sharing contributions
- Whether your 401(k) is invested in stock for the company you work for
Let me explain.
According to the National Association of Retirement Plan Participants (NARPP), companies are legally obligated to hold employees’ 401(k) funds in either an insurance contract or a trust, separate from their business assets.
That means the company you work for or its creditors can’t claim your out-of-paycheck contributions in case of liquidation. As long as that money has been deposited in the trust/insurance contract, it’s safe.
With this background knowledge in mind, let’s discuss how each of the above factors might cause you to lose some of your 401(k).
The Timing of the Liquidation
One of the situations that might put your out-of-paycheck 401(k) contributions at risk is when the company liquidates before the current month’s contribution makes it to the trust/insurance contract.
The Employee Retirement Income Security Act (ERISA) allows employers up to 15 business days after month end to deposit the contribution into their employees’ 401(k) plans. If your employer shuts down before making that deposit, you’ll likely lose your most recent monthly contribution.
Your Employer’s Matching/Profit Sharing Contribution Policy
More often than not, employer matching or profit-sharing contributions come with a vesting schedule.
In such arrangements, your employer agrees to match your monthly contributions up to an agreed percentage of your salary or a dollar amount or issue stock bonuses as long as you remain at the company for a certain period (usually several years). If you leave the company before this period, you lose any stock bonuses or matching contributions that haven’t been fully vested by the time you left.
Now, you’re probably wondering, what does this have to do with liquidation? After all, you aren’t leaving: the company is closing down.
You see, liquidation can happen before some of the profit-sharing/matching contributions provided by the employer become fully vested. In such a case, you almost certainly will lose those contributions.
Losing unvested matching contributions can leave a dent on your 401(k) if the contributions are significant and have accumulated for quite some time.
For instance, some employers can match as much as 50% of your monthly contribution (i.e., if you contribute $1000 per month, they contribute $500, bringing your total contribution to $1500). If you have such a deal with a five-year vesting period, and liquidation happens in the fourth year, you lose quite a lot.
Whether Your 401(k) Is Invested in Your Employer’s Stock
It’s common for employees to invest some of their 401(k) funds in their employer’s stock. If you had already done that before the company shut down, you certainly would lose some of your 401(k) because that stock is now worthless.
Whether that leaves a big dent in your retirement plan depends on how much stock you owned before the liquidation.
A Divorce Settlement Can Impact Your 401(k)
You can also lose part/all of your 401(k) in a divorce settlement. The keyword here is “might” because it depends on whether your retirement assets and benefits are treated as marital property in the settlement.
Provided you and your spouse didn’t sign a prenuptial agreement protecting your 401(k), it’ll likely qualify as marital property, meaning your spouse has legal grounds to go after all or some of it.
Of course, other factors come into play, like when you started building up those funds relative to when you filed your marriage certificate. All things constant, property purchased/earned after the date of the marriage certificate is marital property and is thus subject to division in a divorce settlement.
The way the funds in your retirement plan are split in a divorce settlement will depend on the laws in your state.
In most states, marital property is split equitably, which doesn’t always mean equally. As such, your spouse might end up pocketing more than half of your 401(k) funds, or even the entire thing depending on how solid their case is. Other states split retirement benefits 50/50, but these are fewer than states with equitable distribution laws.
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Conclusion
Indeed, your 401(k) isn’t entirely safe because some or all of it can go away due to a market crash, liquidation of the company you work for, and a divorce settlement.
However, this doesn’t mean that you should bail out of your retirement plan because it’s a critical aspect of personal finance planning. These factors are more the exception than the norm, and most of them are manageable. If you’re worried about losing your 401(k), you can always talk to a financial advisor and come up with better ways to protect it.
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