The answer depends. But, here’s how the Sixth Circuit Court of Appeals answered that question in Davis v. Helbling (In re Davis), No. 19-3117, 2020 U.S. App. LEXIS 17223 (6th Cir. June 1, 2020).
In 2017, Camille Davis filed a bankruptcy petition under Chapter 13 of the U.S. Bankruptcy Code. Chapter 13 gives individuals with a regular source of income the opportunity to propose a plan of repayment to their creditors while under the bankruptcy court’s protection. When Davis filed her petition, she had over $200,000 in debt and less than $39,000 in assets. Most of her debt–$189,000–was unsecured, meaning there was no collateral backing the debt. Chapter 13 allows a debtor to satisfy her unsecured debts by paying all of her disposable income to her unsecured creditors during a 60-month commitment period.
Davis proposed a bankruptcy plan that would pay her unsecured creditors a total of $19,380–equal to 60 monthly payments of $323. To obtain court approval, her plan needed to provide for payment of all of her “projected disposable income” to her unsecured creditors. Although Davis reported gross monthly income of $5,627, she claimed $5,304 in allowable monthly expenses. This included $220.66 in voluntary monthly contributions to her 401(k) plan which Davis had directed her employer to withhold from her wages.
The bankruptcy trustee objected to Davis’s bankruptcy plan, contending that the voluntary 401(k) contributions were disposable income under the bankruptcy code payable to her unsecured creditors. The bankruptcy court agreed. So, Davis appealed.
On appeal, the Sixth Circuit Court of Appeals noted that the bankruptcy code excludes from a debtors estate, “any amount . . . withheld by an employer from the wages of employees for payment as contributions” to a 401(k) plan. Davis argued that the excludable “amount” included any voluntary contributions she continued to make to her 401(k) plan, not just her past 401(k) contributions. The bankruptcy trustee disagreed, suggesting that the excludable amount was simply the aggregate of the 401(k) contributions Davis made BEFORE she filed her bankruptcy petition.
After conducting an exhaustive analysis of several provisions of the bankruptcy code, the Sixth Circuit concluded that post-petition monthly contributions to a debtor’s 401(k) account are excludable from the debtor’s bankruptcy estate if they were regularly withheld from the debtor’s wages PRIOR to the bankruptcy filing. The Court noted that Davis’s employer had withheld $220.66 in monthly 401(k) contributions from Davis’s wages for at least six months prior to her bankruptcy filing. Therefore, any voluntary contributions Davis continued to make after the bankruptcy filing were excludable from her bankruptcy estate.
The Court was quick to add that the bankruptcy code prohibits a bankruptcy court from confirming a Chapter 13 plan proposed in bad faith. Therefore, if a debtor began making 401(k) contributions prior to her bankruptcy filing for the purpose of lowering the amount she might be required to pay her creditors, that might constitute bad faith and require a different result. However, in this case, there was no assertion that Davis had proposed her bankruptcy plan in bad faith. Therefore, she was entitled to have her continued 401(k) contributions excluded from her bankruptcy estate.
So, back to the question I posed at the outset of this post: Are your contributions to your 401(k) plan protected in a bankruptcy proceeding? Maybe. Maybe not. In the Sixth Circuit, the answer depends on whether the debtor began making contributions BEFORE the bankruptcy filing (and possibly for at least six months) and whether the pre-bankruptcy contributions were made in order to avoid paying monies owed to creditors.
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