In the United States, employees often contribute a portion of their annual income to their 401(k) retirement plans. These contributions may fluctuate based on age, income, or additional contributions by employers. At the same time, chapter 13 debtors are often required to pay at least a portion of what is owed to creditors as part of their court-approved payment plans. A court will only approve a debtor's chapter 13 payment plan if a debtor contributes all of his "projected disposable income" to pay creditors over the "applicable commitment period." While disposable income is defined as the "current monthly income received by the debtor ... less amounts reasonably necessary to be expended ... for the maintenance or support of the debtor or a dependent of the debtor," projected disposable income is not actually defined in the Bankruptcy Code. An issue arises for chapter 13 debtors regarding whether they may contribute to their retirement funds while paying back creditors through their chapter 13 plans. If a debtor's retirement contributions are considered part of his disposable income, then it appears that income must be put toward his chapter 13 plan; but if not, perhaps a portion of it may still be put towards the debtor’s 401(k).
Prior to 2005, courts held that voluntary contributions to a 401(k) were part of a debtor’s disposable income. Chapter 13 debtors were required to cease retirement contributions and instead use all disposable income to pay creditors for the duration of their chapter 13 payment plans. In 2005, Congress amended section 541 of the Bankruptcy Code in the Bankruptcy Abuse and Consumer Protection Act (“BAPCPA”), providing that “property of the estate does not include any amount withheld by an employer from the wages of employees for payment as contributions to [a 401(k) retirement plan] except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).” Known as “the hanging paragraph,” this section has caused disagreement among bankruptcy courts regarding whether contributions to retirement plans are excepted from a debtor’s estate in chapter 13 calculations—if so, creditors would not be entitled to funds that a debtor has already contributed to his retirement plan. This memorandum first discusses the differing post-BAPCPA interpretations regarding retirement funds as disposable income, as well as the permissibility of post-petition retirement contributions. The next section will highlight the impact of the good faith requirement on the feasibility of retirement plan contributions throughout the chapter 13 bankruptcy process.