No Means Test Deduction for 401(k) Loan Repayment

By: Leslie M. Hyatt

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

Recently, in In re Egebjerg, the United States Court of Appeals for the Ninth Circuit dismissed, as abusive, a debtor’s chapter 7 petition because it found that the payments owed to the debtor’s 401(k) were not debt and thus, the debtor had excess disposable monthly income.[1] In 2004, the debtor borrowed money from his 401(k) to keep up with financial obligations and personal expenses. To repay the money owed to his 401(k), the debtor had his employer deduct $733.90 from his monthly paycheck. In 2006, the debtor had $31,000 in unsecured consumer debt and filed for chapter 7.[2]

 

Chapter 7 debtors must pass the “means test” to be entitled to relief under chapter 7.[3] The means test looks to debtors’ disposable monthly income to determine if they have enough money left each month to pay back a significant portion of their debt.[4] In In re Egebjerg, the debtor argued that his disposable monthly income was $15.31, after his employer deducted $733.90 per month to repay the debtor’s 401(k) loan.[5] 

 

Section 707 provides that disposable monthly income is calculated by deducting “secured debt” and “necessary expenses” from monthly income.[6] The Ninth Circuit, aligning with the majority of circuits, reasoned that money owned on a 401(k) loan is not secured debt and thus could not be deducted from monthly income to calculate disposable income.[7] To be secured debt, there must be “liability on a claim,”[8] and someone must have a “right to repayment.”[9] When a debtor owes money to his or her retirement account, a debtor-creditor relationship does not exist because there is no liability on a claim or right to repayment; the money owed only reduces a debtor’s retirement savings.[10] 

 

In addition, 401(k) loan repayments were not “necessary expenses” under the means test.[11] Courts look to the categories listed by the Internal Revenue Manual to determine what qualifies as a necessary expense.[12] Only expenses that fall under one of the listed categories can be deducted from monthly income in performing the means test.[13]

 

In some instances, a debtor that fails the means test can proceed under chapter 7 when there are “special circumstances.”[14] Although the majority of courts have held that repaying a retirement account loan is not a special circumstance,[15] the Ninth Circuit suggested that additional circumstances, such as a “life altering” event[16] or borrowing money for a serious medical condition, would be a special circumstance.[17] Here, the debtor did not demonstrate a special circumstance.[18]

 

Further, Congress did not intend for retirement loan repayments to be deducted under the means test.[19] When Congress amended the Bankruptcy Code in 2005, it was aware of case law that explained that retirement account loans were not considered debt. Notably, Congress did not expressly provide for retirement account loans to be considered debt.[20]

 

In the current economic climate, individuals continue to borrow money from their retirement savings to keep up with their creditors. However, chapter 7 proceeding are not meant to protect individuals from poor financial planning, specifically those who decide to borrow money from their retirement savings.[21] In 2005, BAPCPA was passed to promote personal accountability and prevent abuse of the bankruptcy system.[22] In re Egeberg demonstrates BAPCPA’s strict approach to determine if a debtor’s financial situation permits him or her to file for chapter 7 relief.[23] 

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