By: Dean A. Langdon
Chapter 13 bankruptcy offers individuals the ability to avoid a foreclosure or pay debts that are not discharged. This is accomplished by turning over their disposable income to a trustee for a period of 3 to 5 years, who then pays creditors. Debtors are expected to “tighten their belts” to maximize the disposable income available to repay creditors. But what does that mean when it comes to saving for retirement?
Employer-funded pensions are increasingly rare, so if you are not allowed to save for retirement during the 3-5 years of a Chapter 13 plan, retirement may be delayed. Before the last major changes to the bankruptcy laws in 2005, most courts required Chapter 13 debtors to stop making voluntary retirement contributions and use the money to increase their disposable income. The changes made in 2005 added a new section (11 U.S.C. § 541(b)(7)(A)) which specifically excludes money withheld by an employer for retirement plans from the bankruptcy “estate”. So, did that change the law to allow debtors to make retirement plan contributions instead of increasing their disposable income to pay creditors?
Court Decision on Retirement Contributions
Some courts held that this change permitted debtors to continue making retirement contributions. The Sixth Circuit Court of Appeals (which includes Kentucky) ruled in 2012 that although a debtor could continue repaying a 401(k) plan loan during Chapter 13, they could not resume contributions to a retirement plan once the loan was paid back. They would have to use those funds to increase the disposable income paid to the trustee (and creditors). Seafort v. Burden (In re Seafort), 669 F.3d 662 (6th Cir. 2012). Since that ruling, courts have inferred that if a debtor can’t resume retirement contributions during a Chapter 13, they couldn’t continue making such payments at any time during their Chapter 13.
That’s exactly what the bankruptcy judge in Cleveland who handled the Chapter 13 case of Camille Davis ruled. This happened when she tried to continue making monthly contributions of about $220 to her 401(k) plan. The bankruptcy judge authorized Ms. Davis to appeal her decision directly to the Sixth Circuit (which also includes Ohio, Michigan and Tennessee). On June 1, 2020 the Sixth Circuit reversed the bankruptcy judge. It was ruled that the 2005 change in bankruptcy laws excluded retirement plan contributions from disposable income. This allowed Ms. Davis (and all Chapter 13 debtors) to continue making retirement contributions while they were in Chapter 13. Davis v. Helbling (In re Davis), Case No. 19-3117 (June 1, 2020).
Clarifying a Ruling
The Court cautioned that its ruling was narrow. If you weren’t contributing to a retirement plan before filing Chapter 13, this case doesn’t mean you can start. However, if you are regularly contributing to a retirement account you should no longer have to stop those contributions just because you file Chapter 13.
What if you are currently in a Chapter 13, were making such contributions before you filed, and want to start making them again? There are several factors that could affect this. One factor is whether your plan would still be “feasible” and meet the “liquidation test”. Others include whether you are still employed with the same employer, and if you can meet the requirements for amending a Chapter 13 plan. This specific question wasn’t addressed by the Sixth Circuit. However, their ruling provides a basis for making such a request and you should discuss it with your attorney.
The Sixth Circuit recognized that the change to this particular part of the bankruptcy laws was not very clear, which made their ruling complicated. For example, the change was made to a part of the law that defines what is and isn’t included in a bankruptcy “estate,” while there is a totally separate provision about disposable income (11 U.S.C. § 1325). The change in what was excluded from the bankruptcy estate made a specific reference to the section about disposable income.
Standards for Future Chapter 13’s
Because the 2005 law made a “substantial change” to the section about property of the estate, the Court presumed that Congress intended to alter existing law. This existing law had included retirement contributions as part of disposable income. The ruling was by two judges of a three-judge panel, with the third judge filing a dissenting opinion, so there could be a request for the Court to reconsider its ruling, or even have the whole Court consider the issue (an en banc ruling).
This is a welcome decision for individuals who need the relief Chapter 13 offers, but still want to continue saving for retirement, and supports the ability to make a “fresh start” after completing a Chapter 13 plan.
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