It is important to understand what exactly a Chapter 13 Bankruptcy is before a person is able to understand whether or not they can make 401K contributions during the bankruptcy process in a Chapter 13 Bankruptcy. Basically, a Chapter 13 Bankruptcy is a reorganizational process that allows somebody to make good on all of their debts, through a structured way of repaying unsecured creditors.
This plan is proposed to the court and may be approved or rejected depending on how viable the court finds the plan to be.
Goal of a Chapter 13 Bankruptcy
Critically, the end goal of a Chapter 13 Bankruptcy is to be able to pay off all debt and restructure any remaining debt in a way that allows the filer to get current. Any and all disposable income must be allocated to pay off creditors. Essentially, this seems to rule out the idea that a person can make a 401K contribution while in the process of going through a Chapter 13 Bankruptcy.
However, as with many things concerning the law, there are nuances and caveats, which is why it is important to have a skilled Chapter 13 Bankruptcy Attorney handling these matters.
Income reduction
401K or other voluntary retirement contributions will significantly reduce the amount of money that unsecured creditors receive to the repayment plan. As such, bankruptcy trustees tend to frown upon the idea of somebody filing a Chapter 13 Bankruptcy being able to make a 401K contribution. Since the goal of this kind of bankruptcy is to use all disposable income in the Chapter 13 repayment plan for the benefit of the unsecured creditors, any income that goes toward a retirement plan could end up coming directly out of the repayment plan.
This action can also have an adverse effect on the creditors’ payment collection ability. Typically, the only expenses that can be reduced from the disposable income are those that are reasonably necessary for the support and maintenance of the lifestyle of the person filing for bankruptcy.
Case by case basis
However, if the person filing for Chapter 13 Bankruptcy does not live an exorbitant lifestyle and their other expenses are reasonable, and they are nearing retirement, there is a chance that the court will look at the situation on a case-by-case basis. In situations like this where the debtors have a modest lifestyle and may be nearing retirement with a need to make contributions to support themselves, there is a chance that the trustee will allow them to continue to make this kind of retirement contributions.
Because it is such a nuanced situation, courts tend to be split on whether or not to allow a debtor to make 401K contributions. Additionally, if an employer requires that the debtor makes a contribution to the retirement accounts as a condition of the employment, then it is considered a necessary expense and will be considered by the trustee as such.
In this scenario, the amount of the mandatory contribution will be reduced from the disposable income. The best case scenario for somebody in either of these situations is to make sure that they have a qualified Chapter 13 Bankruptcy attorney presenting the case for them.
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Note: This is for information purposes only and does not constitute legal advice.