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What to do with a bankrupt 401(k)

By , - Last modified: April 26, 2013 at 9:56 AM

I regularly counsel clients on what they should do with 401(k)s from old employers, and I have written blogs in the past giving multiple reasons why you may not want to leave your 401(k) money behind.

I addressed topics such as potentially high fees, small amount of investment options and no control over the company choosing new investment options. I did not, however, discuss closure or bankruptcy of the employer.

I currently have a client in this situation, and as I make call after call to custodians, third-party associates, and lawyers on his behalf, I am reminded that much of the trouble that my client is going through could likely have been avoided if he had transferred his assets as soon as he left his job.

Once an employer files for bankruptcy or goes out of business, it becomes very difficult for the former employees to retrieve their funds and often involves considerable expense.

Let me say up front that as long as the funds have been deposited with a custodian, the employee is vested, and there are statements proving the balance of the accounts, then the money still belongs to the employee. It just may take a lot of extra leg work to retrieve it.

The typical procedure for moving money from an old 401(k) to either a new one or a self-directed IRA is usually rather painless. Investors need to establish the new account, fill out the roll-over paperwork from their old company and have a trustee from the previous employer sign off indicating that the individual is no longer employed at the company.

The tricky part is accomplishing these steps when the company no longer exists. It may be difficult or nearly impossible to find anyone from your previous employer to sign off on the necessary documents. The custodian of the funds (the place where your 401(k) is invested) typically will not make an exception on this to allow you access to the funds. So while your money is still there, it can’t be moved.

What should you do if you find yourself stuck in this situation?

You will probably need to find a lawyer who handles bankruptcies or securities law, a rather costly step that may be avoided under normal circumstances. It might help if you can find other previous employees in the same boat, so that you can join together to share in the costs of the proceedings.

As I said, this likely can be avoided if you immediately roll over your old 401(k) over upon leaving a job. It could save you months of headaches, and a few legal bills to boot. As always, consult with a qualified financial professional to help make this transition as painless as possible.


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