Is a 401(k) Contribution a Legitimate Expense in Bankruptcy?

By Kevin Owen

By the time you file for Chapter 13 bankruptcy protection, you may be on the verge of discontinuing contributions to your 401(k) retirement account in order to make your credit card payments. However, after submitting your bankruptcy petition, you may be permitted to continue making reasonable contributions to your 401(k) retirement account so you can plan for your financial security after emerging from bankruptcy.

Chapter 13

Under Chapter 13 bankruptcy, your debts are consolidated into a repayment plan lasting from three to five years. Your payments are made to a court-appointed trustee who then pays them to your creditors. Once you file your bankruptcy petition, an automatic stay goes into effect preventing foreclosure, repossession, lawsuits and other collection efforts by creditors. After successful completion of the repayment plan, any remaining debts are forgiven upon discharge of the case from bankruptcy court.

Allowable Deductions

The amount of each month's payment under the bankruptcy plan is determined by your disposable income — your after-tax income less allowable living expenses. These allowable deductions are intended to provide you sufficient money to pay your necessary costs of living, such as food, day care, rent or mortgage payments, car payments and utilities. Any remaining income that is not deductible is designated for payment to your creditors.

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401(k) Contributions

Funds used for investment in stocks, bonds and other investment accounts do not qualify as allowable deductions of disposable income. Although reasonable contributions to a 401(k) account are not considered disposable income, they may be treated as an allowable expense depending on the circumstances. Therefore, when you file a Chapter 13 bankruptcy petition, you may be permitted to continue contributing to your retirement account.

Limitations

In some circumstances, you may not be permitted to increase your 401(k) contributions or begin contributing to your 401(k) retirement account if you were not contributing to it prior to filing for Chapter 13 bankruptcy. The bankruptcy trustee, whose role is to protect your creditors' interests, may object to your placing these funds into your retirement savings instead of paying your creditors.

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Do You Lose Your 401(k) if You Go Bankrupt?
 

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The amount of your income is a qualifying factor for both Chapter 7 and Chapter 13 bankruptcies. For Chapter 7, it determines whether you're eligible, and with Chapter 13, it affects the length of your repayment plan -- the maximum time is five years. During this period in a Chapter 13 bankruptcy, you must provide the trustee with your disposable income each month, and the trustee uses this money to pay down your debts.

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