What Happens to Your 401K if Your Bank Collapses?
The recent stories of bank failures and collapses are relatively standalone, extreme cases. From what we can tell, we’re not looking at another Lehman Brothers situation! However, this still understandably causes some anxiety and fear regarding our bank accounts, investments, and the banking system as a whole.
On top of that, the Federal Reserve has raised interest rates over the last year. This could further impact financial institutions, stocks, and the housing market.
Many are asking, “Will other banks collapse? And, if so, what happens to my retirement if my bank closes?”
First—don’t panic! We’re not expecting a repeat of the Great Depression anytime soon!
But we still wanted to tackle the question of what happens to a 401(k) in the event of a bank collapse and offer some common sense advice on how to protect your 401(k) against economic downturns and potential financial crises.
How does a 401(k) work?
To understand how to protect a 401(k), it’s helpful to know how they work. We’ll keep it brief:
A 401(k) is an employer-sponsored plan. You sign up for an account through your employer. Your contributions are typically made directly from your paycheck. The money goes to your plan’s administrator or custodian, who invests it into various assets, such as stocks, bonds, and mutual funds. Your investments grow slowly and steadily until you retire and take distributions.
Your contributions are tax-deferred, meaning you pay no income taxes on that money before depositing it into your plan. However, your distributions are considered taxable income. So, you’ll have to pay taxes as usual throughout your retirement.
Are 401(k) plans FDIC-insured?
Not exactly. The FDIC only insures deposits, not investments. Even then, the FDIC only protects up to $250,000 in deposits per depositor per bank. If your 401(k) funds exist in various bank deposits, they could be insured. However, most 401(k)s are investment plans that don’t qualify for insurance.
The FDIC does insure IRAs, but only if the funds are in qualifying deposit types.
For easy reference, deposits insured by the FDIC include:
- Checking accounts
- Savings accounts
- Money market accounts
- CDs (Certificates of Deposit)
Investments not insured by the FDIC include:
- Mutual funds
What happens to a 401(k) when the bank collapses?
99.8% of the time, a bank collapse will not cause your 401(k) to go up in smoke and force you to start saving for retirement all over again. This is because 401(k) assets are typically held with a third-party custodian not affiliated with the collapsed bank. In addition, the money you contribute to your 401(k) typically gets invested in mutual funds managed by fund companies separate from and not affiliated with the collapsed bank.
The one exception to this may be if your employer offering the 401(k) was the particular bank that collapsed. In that scenario, your 401(k) may get wrangled into the receivership process, and/or any contributions that are not “vested” could be subject to loss.
The stock market problem
So, while the FDIC might not insure your 401(k), it’s unlikely to be lost during a bank collapse. However, there could be an indirect impact on your retirement plan. If a collapse causes a banking panic, it could affect the stock market. Because a 401(k) is composed mainly of various investments, this could cause your plan to lose some money. If this worries you, consider contacting a financial advisor for advice. They could recommend actions to shuffle around your investments and minimize potential losses.
How to protect your 401(k) in an economic downturn
Mitigating your 401(k) risks during an economic downturn takes planning and strategy. However, there are a few simple steps you can follow to help protect your retirement against significant losses. Keep in mind that results may vary depending on your specific circumstances.
Here are steps you can take to protect your 401(k) in an economic downturn:
Don’t empty your account
401(k) plans are intended for long-term growth. There will always be ups and downs. With a long-term perspective, you can avoid panicking and ride out the downturn—it won’t last forever. Though it might be down now, many 401(k) investments are relatively low risk. They should typically survive the downturn and rise back up once the worst has passed.
A diversified portfolio includes investments in various asset classes: stocks, bonds, funds, cash, etc. Each comes with its own risk factors. While some of your investments might be at risk, others should remain relatively safe. This can help mitigate losses during a downturn.
Rebalance your portfolio
It’s easy to set-and-forget a 401(k) account. However, it’s important to check in with your plan periodically. Do the investments still match your risk tolerance levels? Can they still help you reach your retirement goals? Meeting with a financial advisor can help you rebalance your portfolio. Doing so is an excellent opportunity to move investments around to ensure the risks you’re taking during a downturn are ones you’re willing to take.
During a downturn, you should expect some losses. However, halting contributions can lead to even bigger losses. While investing during a downturn can be scary, not contributing can seriously deteriorate your retirement income. 401(k) plans are designed to grow with regular contributions: the more you contribute, the more you invest, and the bigger your plan can grow. Continuing to contribute also helps ensure employer contributions, which are essentially free money.
Resist the allure of fast growth
Fast-growing stock can be incredibly alluring—after all, who doesn’t want a lot of money tomorrow?! However, it doesn’t always pan out and can often be incredibly risky. Many investors will protect their money during an economic downturn or financial crisis by shifting it into slower-growing, “value” stocks. This puts your money at even greater risk, as those fast-growing stocks can suddenly start losing value.
Protections in place for a 401(k)
While the FDIC doesn’t insure your 401(k), many protections exist. In 1974, the United States passed the Employee Retirement Income Security Act (ERISA). ERISA provides protection and sets minimum standards for “defined benefit” and “defined contribution” retirement plans.
Key among ERISA’s protections is asset separation. This means that the assets in each plan are not owned by the banks holding the funds, employers offering the plan, or the plan participants. The assets are kept separate and technically owned by the plan administrator. This protects your 401(k) from seizure by creditors even if you, your bank or your employer goes bankrupt. (Don’t worry—once you take distributions, that money is all yours!)
For those with a pension, the ERISA also created an agency called the Pension Benefit Guaranty Corporation (PBGC). This helps protect pensioners if their plan provider goes bankrupt or closes during an economic downturn.
Lastly, if your employer or plan administrator closes, your 401(k) is still protected under federal law. In either case, your plan will typically get automatically rolled over into a new account as a new sponsor takes it over. You should be notified of where your plan is going and how to access it. If you can’t find your plan, you can check the National Registry of Unclaimed Retirement Benefits to find it.
Of course, if your employer closes, you can always roll over your 401(k) into a new plan at your new employer rather than risk leaving it behind.