After several interest rate hikes from the Federal Reserve, many have braced for stock market volatility in their 401(k) plans. But experts say some plans could face another risk: employer bankruptcy.
Generally, your 401(k) is safe from creditors in the case of bankruptcy, based on protection from the Employee Retirement Income Security Act, or ERISA.
“A 401(k) plan is really one of the safest vehicles that you can save money in because of the ERISA protection from bankruptcy and creditors,” said certified financial planner Dan Galli, owner at Daniel J. Galli & Associates in Norwell, Massachusetts. But some investors may feel “a little too secure,” and it’s important to know the risks, he said.
Single stock risk can be ‘incredibly dangerous’
When an employer files for bankruptcy, large concentrations of that company’s stock in a 401(k) can be “incredibly dangerous,” according to Galli.
“Often, clients have 40%, 50%, 60% or even 100% of their account invested in stock of the company,” he said, noting that aggressive investors shouldn’t allocate more than 20% into company stock and conservative investors should stay below 10%.
“There’s a strong likelihood that stock is going to take a deep dive,” said CFP Ashton Lawrence, director at Mariner Wealth Advisors in Greenville, South Carolina. “That’s why most advisors are proponents of diversification.”
Galli said there’s also a hidden risk with “guaranteed interest accounts,” a common 401(k) asset that provides interest for a set amount of time. While it’s an attractive option for conservative investors, the underlying assets can decline in value.
Typically, these contracts are backed by insurance companies that invest in bonds, which generally fall in value as market interest rates rise. To liquidate the entire account, the bonds could be sold at a loss, Galli said. “And that loss always gets passed on to the account holder.”
When a 401(k) plan shuts down, employees may see “adjustments” to their guaranteed interest accounts, which reduce the assets’ value.
Although 401(k) plans from previous employers may also be subject to these risks, there are several things to consider before rolling over old accounts to a new 401(k) plan or individual retirement account.
For example, you may weigh investment options and fees, convenience and creditor protection. “I wouldn’t say there’s one answer that fits all,” said Lawrence. “It really depends on each client’s situation.”