Circuit Court Decision on 401(k) Contributions in Chapter 13 Bankruptcy Solidifies Florida District Court Ruling

On June 1, 2020, in a 2-1 decision, the United States Court of Appeals for the Sixth Circuit (6th Circuit) ruled that the voluntary contributions to an employer’s qualified retirement plan (e.g., a 401(k)) by a person in Chapter 13 bankruptcy are excluded from “disposable income” for purposes of determining how much of her post-filing income must be paid over to her pre-filing creditors. For debtors domiciled in Florida, the 6th Circuit ruling solidifies a prior ruling discussed below by the U.S. District Court, Southern District of Florida.

Recall that a Chapter 7 bankruptcy is a liquidation, and Chapter 13 is a repayment plan. In Chapter 7, all of your eligible debts are discharged. The downside is that the trustee will take all of your non-exempt assets to satisfy as much of your debt as possible. In order to file under Chapter 7, a debtor must meet the “means test”^[i] or have a majority of their debt be non-consumer debt (e.g., an entrepreneur uses their personal credit card to fund their business which failed; that would likely be a non-consumer debt). Even if Chapter 7 is not available, a debtor can still seek the protection of bankruptcy either through Chapter 11 or Chapter 13. Further, because the Trustee can take your non-exempt assets in Chapter 7, many debtors prefer to go the route of Chapter 13.

Chapter 13 is commonly referred to as the “wage earner’s plan.” Under Chapter 13, a bankruptcy plan cannot be approved unless the plan provides for all of the debtor’s projected disposable income to be paid towards the balances owed to unsecured creditors. Typically, under a Chapter 13 plan, payments are made for 60-months (5-years).^[ii]  Chapter 13 defines “disposable income” as the debtor’s current monthly income less amounts reasonably necessary to be expended for the maintenance or support of the debtor.

In RESFL Five LLC v. Ulysse, 16-62900 (S.D. Fla. Sept. 29, 2017), the Court based its ruling on the majority view that the bankruptcy code does not limit a debtor’s ability to make voluntary contributions to a retirement account whether they are made pre- or post-petition. The judge in RESFL Five LLC saw no statutory basis for allowing retirement contributions only if the debtor was making them before the bankruptcy started; which means even if you were not making contributions to your retirement account pre-filing you can do so post-filing.^[iii]

Take Away from Widerman Malek:

A person in Chapter 13 bankruptcy who regularly made contributions prior to the filing of bankruptcy may continue to do so at the same rate after the filing of bankruptcy. In fact, a Chapter 13 debtor who files in Florida but did not make any contributions prior to the filing may be able to factor post-filing retirement contributions into their Chapter 13 plan. This means that after a person gets their fresh start in the bankruptcy plan, they can begin saving for their future as they pay their past debts in a plan over time. If you have questions or are considering bankruptcy, please reach out to us to discuss how this planning can help you achieve your goals.