In a recent decision, a Massachusetts Bankruptcy Judge ruled that a Chapter 13 debtor may deduct contributions to a 401(k) retirement plan while in bankruptcy. It’s a ruling anyone contemplating chapter 13 should pay attention to.
The debtor’s schedules listed his gross income as $9,666.67 per month. After taxes, insurance and 401(k) contribution of $966.66, that left $5,604.67. The debtor’s plan proposed to pay unsecured creditors a total of approximately 49% over the 60 month span of the plan. The trustee raised a number of issues (many of which are not germane to the topic here), including the propriety of the debtor’s 401(k) deductions.
The trustee argued that such large deductions into the 401(k) demonstrated a lack of the debtor’s good faith. The deductions amounted to 10% of the debtor’s gross income. If debtor stopped the high 401(k) deductions, the debtors would receive a 100% distribution over the life of the plan.
Under Section 541(b)(7), a debtor’s 401(k) contributions are not considered property of the bankruptcy estate. In addition, those amounts withheld are not considered “disposable income” as is defined by Section 1325(b)(2). In overruling the trustee’s objections, the Court noted that the debtor was only “taking advantage of what the law allows.”
Some might argue that this makes no sense: the debtor can pay off only half of what he owes his creditors, while at the same time, setting aside more than $50,000 over the life of the chapter 13 plan. It’s hard to imagine that the folks at MBNA had that in mind when they were lobbying Congress to change the bankruptcy laws. Yet the Court noted, this is exactly what Congress intended: “by excluding 401(k) contributions from property of the estate and expressly removing them from the definition of disposable income under Section 1325(b)…Congress has implemented a policy of protecting and encouraging retirement savings.”
Good faith is still the rule to play by. Future chapter 13 debtors who contribute to a retirement plan may not enjoy the same result if their contributions exceed the limits permitted by their 401(k) plans. But for those folks I meet with who tell me “all of my income goes to my bills, and I have nothing in my retirement account”, this should be welcome news.
In re Mati, Bankr.D.Mass, Chapter 13 case no. 07-13323
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- Filing Bankruptcy: Timing can be Everything in Chapter 13
- Do It Yourself Chapter 13: The Road To Failure
Tags: 401k, Bankruptcy, Bankruptcy Abuse Prevention & Consumer Protection Act of 2005, Chapter 13
