401(k) Loan Repayments and Chapter 7 Bankruptcy

Clients often borrow from a 401(k) plan before filing for bankruptcy. As bankruptcy practitioners, we hate to see this happen. Retirement funds are exempt from creditor collection. Our clients often borrow against an exempt asset to pay an ordinary unsecured debt. 401(k) loan repayments can be burdensome.  The standard rules that would require a lender to ask whether a borrower can afford loan payments do not apply to 401(k) borrowing.  Instead, the limit is usually set by stating the owner of the retirement plan can borrow up to 50% of the total value.

Anyone with experience in the workforce knows that employers will not simply stop deducting 401(k) loan repayments from paychecks.  Employers assert that collecting the payments is a duty under Federal law and ensures the integrity of the retirement system. One would think, then, that 401(k) loan repayments would be deducted or otherwise given credit as an expense on the Chapter 7 means test. That conclusion is, unfortunately, incorrect.  401(k) loan payments are not considered mandatory deductions in a Chapter 7 case.

This result is all the more puzzling given that a Chapter 13 debtor is allowed to pay back the 401(k) loan ahead of all creditors. For the number of months that remain in a 401(k) loan repayment plan, the Chapter 13 debtor reduces the Chapter 13 plan payment by the amount of the 401(k) loan payment. 

Mansfield Law Corporation recently litigated a case against the County of Ventura testing whether 401(k) loan repayments could be voluntarily stopped by a debtor. The short of it is that they cannot. The docket materials constitute an exploration of how this fact contradicts and undermines the Ninth Circuit case of In re Egebjerg.   You can learn more about the case and this issue on our website

This office believes that In re Egebjerg was wrongly decided and needs to be reconsidered whan an appropriate case presents itself.