Q: What happens to my pension if my employer goes bankrupt?

A: With the recent Chapter 11 filing of American Airlines, the issue of retirement benefit security is again in the spotlight. If your company has a defined contribution plan (401(k), Simple or SEP plan), your account is set aside and held by a third-party custodian, so that contributions made by you or your employer are secure and fully protected in the event of bankruptcy.

For private sector workers with a traditional pension plan, the story is a bit different. Known as defined benefit plans, pensions typically pay a fixed annual income that are ongoing obligations of the employer.

In the event of insolvency, retirement income payments are partially guaranteed by a U.S. government

agency called the Pension Benefit Guarantee Corp..

Prior to 1974, the traditional pension was the predominant form of retirement plan. It depended upon current contributions by the employer to fund benefits to be paid out well into the future. During periods of financial distress, pension contributions were often the first expenditure to be cut or eliminated.

In extreme cases, some companies raided prior contributions, leaving nothing in the till to cover future payouts.

If a company went bankrupt, retirees sometimes ended up receiving none of their promised benefits.

Congress addressed the situation in 1974 by enacting a sweeping pension reform law, the Employee Retirement Income Security Act, referred to by the acronym ERISA.

One important element of ERISA was the creation of the PBGC to ensure that private pensioners do not end up losing everything if their employer goes bust.

When a company enters bankruptcy, the PBGC reviews the status of any defined benefit plans and recommends a course of action.

First and foremost, the agency tries to help the employer maintain the plan intact, by adjusting benefits or funding levels to make the plan viable. In 2011, 19 plans worth $2 billion emerged intact from bankruptcy proceedings thanks to PBGC.

In the event that the company cannot correct plan deficiencies, or if ordered by the bankruptcy court judge, PBGC steps in and takes over the pension plan. In that event, PBGC assumes all the duties of running the plan and paying the beneficiaries.

While protected from a wipeout, retirees do not necessarily receive the full benefits promised by the original plan. Currently the legal limit (set by Congress and adjusted annually) is $54,000 per year for a 65-year-old retiree.

The PBGC generally receives no taxpayer funding. Employers with defined benefit plans are required to pay insurance premiums to the agency. These premium payments, along with plan assets taken over and investment returns on those assets, are the sources of operating revenue to the agency.

Thanks to a recent spike in large plan defaults, PBGC is running a record deficit this year of $26 billion and is seeking congressional approval to hike premium rates.

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Christopher A. Hopkins CFA, is a vice president at Barnett & Co. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by emailing him at dflessner@timesfreepress.com.