Court Finds 401(k) Loan Payoff Frees Income to Pay Creditors

The most interesting part about this is that it even came up… Reeve

February 16, 2012 ( – A federal appellate court has found income that becomes available to bankrupt debtors after their 401(k) loans are fully repaid is “projected disposable income” that must be turned over to the trustee for distribution to unsecured creditors.

 The 6th U.S. Circuit Court of Appeals said the freed up income may not be used to commence voluntary 401(k) plan contributions.  

The appellate court agreed with a  Bankruptcy Appellate Panel (BAP) ruling in favor of the trustee for the debtors in the case that exclusions from property of the estate and disposable income for contributions to a qualified retirement plan found in 11 U.S.C. of the Bankruptcy Code and § 541(b)(7) of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), both only apply to those cases where a debtor is contributing as of the commencement of a bankruptcy case, and the post-petition income that becomes available after a debtor completes repayment of a 401(k) loan is not excluded from property of the estate or disposable income and must be committed to a Chapter 13 bankruptcy plan.  

According to the appellate court, prior case law adopts a “plausible policy that Congress intended to encourage Chapter 13 debtors to continue making retirement contributions, but did not intend to permit debtors to increase their rate of contribution to the detriment of their creditors.”  

The 6th Circuit’s opinion said the easy inference is that Congress did not intend to treat voluntary 401(k) contributions like 401(k) loan repayments, because it did not similarly exclude them from “disposable income” within Chapter 13 itself. The court noted that § 1322(f) states that “any amounts required to repay such loan shall not constitute ‘disposable income’ under section 1325.”   

Congress also does not consider voluntary contributions as “reasonable and necessary expense[s]” deductible from “disposable income,” because it expressly excluded them from the list of “necessary expenses” in Official Form 22C, which provides the formula for calculating “reasonable and necessary expenses” of above-median income debtors, the court concluded.