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Sixth Circuit Rules that Monthly 401(k) Contributions can be Excluded from “Projected Disposable Income” Under a Chapter 13 Plan

Saving for RetirementA Chapter 13 bankruptcy plan requires a debtor to satisfy unsecured debts by paying all “projected disposable income” to unsecured creditors over a five-year period. In a recent case before the U.S. Court of Appeals for the Sixth Circuit (the “Sixth Circuit”), the court grappled with whether a Chapter 13 debtor’s wages that are contributed to an employer-sponsored retirement plan are considered disposable income under the Bankruptcy Code.[1]

The issue is one that has caused considerable disagreement, and resulted in different approaches, among the bankruptcy courts. In this case, the Sixth Circuit, in a ruling the court described as “narrow,” ruled that a debtor’s voluntary retirement contributions should be excluded from disposable income.

Case Background

The debtor in this case proposed a Chapter 13 plan that excluded $220.66, the amount that her employer withheld from her monthly wages (prior to the bankruptcy) as a 401(k) contribution, from her projected disposable income available to pay unsecured creditors. She sought to continue making those contributions during her bankruptcy.

The U.S. Trustee objected to the debtor’s plan, arguing that wages withheld as voluntary 401(k) contributions are considered disposable income under the Bankruptcy Code. According to the U.S. Trustee, to the extent such amounts are excluded, the debtor’s proposed plan would not pay all of her projected disposable income to her unsecured creditors as the Bankruptcy Code requires.

The bankruptcy court sided with the U.S. Trustee, noting that it felt bound by dictum found in the prior Sixth Circuit decision of Seafort v. Burden (In re Seafort), 669 F.3d 662, 674 n.7 (6th Cir. 2012), which suggested that the Bankruptcy Code always counts voluntary retirement contributions as disposable income, even if the debtor began making those contributions prior to bankruptcy.

The debtor then put forth a new plan which included her monthly 401(k) contributions as part of disposable income, and then objected to her own plan, preserving her right to appeal.

The Sixth Circuit’s Analysis

Section 1325(b)(1) of the Bankruptcy Code provides that, upon objection, a bankruptcy plan cannot be approved unless all of a debtor’s “projected disposable income” is paid to unsecured creditors during the applicable period. Disposable income is the amount of monthly income remaining after expenses required for the maintenance of and support of the debtor. In some instances, pursuant to Section 1325(b)(2) of the Bankruptcy Code, that sum is adjusted for changes “known or virtually certain” to occur during the commitment period.

In its analysis, the Sixth Circuit noted that, prior to the 2005 amendments to the Bankruptcy Code, there was consensus among the bankruptcy courts that wages voluntarily withheld as 401(k) contributions formed part of a debtor’s disposable income. Therefore, such amounts were routinely available to unsecured creditors as part of a Chapter 13 plan.

After 2005, following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”), bankruptcy courts began adopting different approaches for the treatment of 401(k) contributions as disposable income. The splintering of opinions resulted from what is known as the “hanging paragraph” in Section 541(b)(7)(A) of the Bankruptcy Code, which defines what property should not be included as “property of the estate” in a bankruptcy case. While Section 541(b)(7)(A) provides that amounts withheld by an employer for contribution to an employee’s 401(k) plan are to be excluded from property of the estate, the “hanging paragraph” at the end of the section states “except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).”

On appeal, the debtor argued that the hanging paragraph excludes 401(k) contributions from disposable income for purposes of § 1325(b)(2). The U.S. Trustee, on the other hand, argued that the proper interpretation of the hanging paragraph is that a debtor’s pre-petition contributions to a 401(k) are to be excluded, but ongoing contribution amounts are disposable income.

The Sixth Circuit noted that the majority of courts agree with the debtor’s interpretation. However, other courts have held, using one of three different interpretations of the hanging paragraph that only pre-petition contribution amounts are to be excluded from disposable income. The Sixth Circuit itself, in dictum in the Seafort case, previously rejected the idea that post-petition 401(k) contributions should be excluded. In summarizing the disparate approaches to the issue at hand, the Sixth Circuit stated: “BAPCPA’s insertion of the hanging paragraph into § 541(b)(7) has taken us from an ‘overwhelming consensus’ among bankruptcy courts...to four competing views of whether voluntary retirement contributions constitute disposable income in a Chapter 13 bankruptcy.”

In reaching the conclusion that post-petition 401(k) contributions should not be included as part of a debtor’s disposable income, the Sixth Circuit explained that while the statutory language constitutes a “grammatical oddity,” its holding gives “a meaningful effect” to Congress’s instruction in Section 541(b)(7) that 401(k) contributions “shall not constitute disposable income.”

The Sixth Circuit noted that its decision, seemingly at odds with its holding in Seafort, in fact builds on Seafort. The debtor in Seafort sought to exclude from her disposable income 401(k) contributions that she had not been making prior to bankruptcy. In this case, the debtor was making 401(k) contributions before she filed for bankruptcy.

Accordingly, the Sixth Circuit concluded that “the hanging paragraph is best read to exclude from disposable income a debtor’s post-petition monthly 401(k) contributions so long as those contributions were regularly withheld from the debtor’s wages prior to her bankruptcy.” However, the court recognized that its interpretation of the hanging paragraph “may necessitate a more searching good-faith analysis to minimize the risk that a debtor contemplating bankruptcy might begin making 401(k) contributions prior to filing to lower the amount she must ultimately repay her creditors.”

If you have further questions regarding this case or bankruptcy questions in general, contact Patricia Scott at 517.371.8132 or at pscott@fosterswift.com.

[1] Davis v. Helbling, No. 19-3117 (6th Cir. Jun 1, 2020)

Categories: 6th Circuit Court of Appeals, Chapter 13

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 concentrates her practice in the areas of Bankruptcy, Finance, Collections, Real Estate, and Commercial Litigation. In the bankruptcy area she represents creditors and Chapter 7 Trustees in all aspects of bankruptcy. Patricia also represents small and mid-sized businesses to large corporations in multi-faceted litigation matters in state and federal court. Her work with financial institutions includes collections, loan workouts, foreclosures, receiverships and various complex banking and finance issues. 

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