Bankruptcy Court: You Can Save for Retirement in Chapter 13

In a recently issued order, Judge Pamela S. Hollis, of the Bankruptcy Court in Chicago, ruled that individuals in chapter 13 bankruptcy cases can make 401(k) contributions while making payments to creditors under a debt repayment plan. The order, which was issued on October 22, 2013, in the case In re Hall, confirms that individuals in chapter 13 cases may continue to plan for their future while addressing their current debt problems. Under chapter 13 of the Bankruptcy Code, an individual proposes a plan to repay creditors over a three- to five-year period. The individual must commit all of her “disposable income” to the plan. “Disposable income” is calculated using a formula defined by the Bankruptcy Code. The debtor in the Hall case had proposed to pay $500 per month to her creditors and $700 per month to her 401(k). The chapter 13 trustee objected to the debtor’s plan and asked the Court to decide whether a chapter 13 debtor could continue making voluntary 401(k) contributions, or whether those amounts were part of “disposable income” that had to be paid to creditors through the chapter 13 plan. Courts outside of Chicago have addressed this issue before, and the Hall order outlines the three competing rules that those other courts have developed. First is the majority rule: voluntary retirement contributions are not “disposable income,” so debtors can continue to make them during a chapter 13 plan period. Second is the opposite rule: voluntary retirement contributions are “disposable income” and must be paid to creditors while a chapter 13 plan is in effect. Third is the middle ground: a debtor may continue to make contributions she made before filing for bankruptcy, but may not increase the contribution level or begin making contributions for the first time. In adopting the majority rule—that a debtor may make voluntary contributions during a chapter 13 case, even if she has not made them before bankruptcy—the Court relied on a close analysis of the text of the Bankruptcy Code, as well as Congress’s expressed policy of encouraging debtors to save for retirement. The Court’s rule is favorable to individuals considering a chapter 13 bankruptcy filing. A bankruptcy filing does not mean choosing between relief from debts now and financial security in retirement. Instead, an individual can repay her creditors, get a bankruptcy discharge, and continue (or even begin) planning for retirement, all at the same time. It is important to note, however, that Judge Hollis is just one of 12 bankruptcy judges for the Northern District of Illinois, the judicial district encompassing Chicagoland. The judges can and often do disagree with each other, and any one of them may preside over a particular case. Another judge may decide that 401(k) contributions are “disposable income” and must be paid to creditors. Until that happens, though, the Hall order provides a basis for individuals to propose debt repayment plans that protect their retirement as well.

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