In Chapter 13 bankruptcy, you are required to pay all of your disposable income into your repayment plan. But if you would like to contribute to your 401k or other retirement account during your Chapter 13 case (these are called postpetition contributions), can you deduct the contributions when calculating your disposable income? The answer depends on your jurisdiction. Unfortunately, if you file for Chapter 13 bankruptcy in California, you typically can’t make voluntary postpetition contributions to your retirement account to reduce your disposable income.
Disposable Income in Chapter 13 Bankruptcy
In Chapter 13 bankruptcy, you pay back some or all of your debts through a repayment plan. How much you have to pay generally depends on several factors including:
- your income and expenses
- the amount of nonexempt property you own (learn about how your nonexempt property affects your Chapter 13 bankruptcy plan payment), and
- the types of debt you have (learn about debts you must pay back in Chapter 13 bankruptcy).
You must contribute all of your disposable income into your Chapter 13 plan to pay your unsecured creditors. Disposable income is your monthly income less any amounts you spend on:
- expenses that are reasonably necessary to support yourself and your dependents, and
- qualified charitable contributions up to 15% of your gross income.
How Do Retirement Contributions Affect Your Chapter 13 Plan?
In most cases, the amount you must pay your unsecured creditors through your Chapter 13 plan depends on your disposable income. When calculating your disposable income in bankruptcy, you can deduct any expenses that are reasonably necessary for your support.
Are voluntary contributions to your 401k or other retirement accounts reasonably necessary for your support? Some bankruptcy courts say yes, and allow debtors to exclude voluntary retirement contributions from their Chapter 13 disposable income calculation. But not so in California -- usually you cannot use voluntary postpetition retirement contributions to reduce your disposable income.
Why does the trustee care? If you contribute a portion of your monthly income to your retirement account, it means that you can’t pay as much into your bankruptcy plan.
Postpetition Retirement Contributions in California Chapter 13 Bankruptcy Cases
In 2012, a Bankruptcy Appellate Panel (BAP) decision in the 9th Circuit (which includes California) held that Chapter 13 bankruptcy debtors can’t exclude voluntary postpetition retirement contributions from their disposable income calculations. In re Parks, 475 B.R. 703 (B.A.P. 9th Cir. 2012).
This essentially means that in California you can’t make voluntary postpetition retirement contributions to reduce your disposable income in Chapter 13 bankruptcy. If you continue to make retirement contributions after filing your case, it is likely that the bankruptcy trustee will argue that you should be paying those amounts to your unsecured creditors in your repayment plan.
Who Is Covered by the BAP Decision?
The 9th Circuit Court of Appeals hasn’t officially ruled that all bankruptcy courts in the 9th circuit must follow BAP decisions. However, most California courts do follow BAP decisions (unless a higher court has ruled to the contrary). If you want to continue making retirement contributions in Chapter 13 bankruptcy, talk to a knowledgeable bankruptcy attorney in your area to learn how your local bankruptcy court treats postpetition retirement contributions.
In addition, if your income falls below the median income in your state for a similar household, you may have a valid argument to continue your retirement contributions (discussed below). You can find your state’s median income figures on the website of the U.S. Trustee.
Your Income Might Make a Difference
Whether your income is above or below the state median income determines which expense figures you can use in Chapter 13 bankruptcy.
The Parks decision involved debtors whose income was greater than the state median income. For Chapter 13 debtors with above median income, expenses are usually considered to be reasonably necessary if they are the types of expenses allowed by the bankruptcy means test. The Parks court reasoned that because voluntary retirement contributions are not listed as reasonable and necessary expenses under the means test, the debtors shouldn’t be allowed to deduct them from their disposable income.
But a Washington bankruptcy court recently allowed a debtor with below median income to deduct his postpetition retirement contributions when determining his disposable income. In re Bruce, 484 B.R. 387 (Bankr. W.D. Wash. 2012).
In the Bruce case, the court stated that if a debtor has below median income, whether his or her expenses are reasonably necessary is determined by the court, and not by the means test rules. Depending on the debtor’s individual circumstances, the court may find that his or her postpetition retirement contributions are reasonably necessary and should be excluded from the disposable income calculation.
What Does This Mean in California?
Washington bankruptcy court decisions are not binding on (meaning they don't have to be followed by) California courts. If your income is below the state median, you can argue that under the Bruce decision your postpetition retirement contributions should be considered to be reasonably necessary. But a California bankruptcy court may not agree.
What If Your Employer Requires You to Make Retirement Contributions?
If your employer requires you to make contributions to a retirement plan as a condition of your employment, you can typically exclude those amounts from your disposable income in Chapter 13 bankruptcy.
What Happens If You Are Paying Back a Retirement Account Loan?
If you borrow money from your retirement account, you can deduct your monthly loan payments when calculating your disposable income. But when you pay off your retirement loan, you will usually have to contribute the amount of your monthly loan payment to your Chapter 13 plan. (Learn more about retirement account loan payments in Chapter 13 bankruptcy.)