Is a voluntary 401k contribution a “reasonable and necessary” expense and therefore excluded from disposable income for purposes of a Chapter 13 case? Does it matter whether the debtor is above or below median? Courts in the 9th Circuit and in Massachusetts have recently considered this issue.
The Bankruptcy Appellate Panel of the Ninth Circuit considered the question for an above-median debtor in In re Parks, 475 B.R. 703 (9th Cir BAP Mont. 2012) and concluded that a voluntary 401k contribution is not reasonably necessary and cannot be excluded from disposable income under 11 U.S.C. § 1325(b)(2).
Other courts, however, have held the opposite. See In re Drapeau, 2013 WL 85154 (Bankr. D.Mass. 2013) and cases cited therein at fn. 10. The court in Drapeau specifically rejected the analysis in Parks and characterizes the position in Parks as the “minority view.”
The differing conclusions appear to turn on interpretations of § 541(a)(1) (defining property of the estate) and § 541(b)(exclusions from property of the estate). Courts have found a conundrum in the structure of subsection 541(b)(8)(A), which appears to exclude from the property of the estate any amount withheld by an employer for ERISA qualified plans, a deferred compensation plan or a tax-deferred annuity. The subsection does not end there, however. It also includes a “hanging paragraph” that reads, “except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).” The conundrum? Does the “hanging paragraph” apply to all contributions, both pre- and post-petition? Or, does it exclude from disposable income only contributions made pre-petition?
Furthermore, the courts ask, did Congress intend that voluntary contributions to 401k plans be excluded from disposable income just as 401k loan repayments are? Or, by its failure to include a specific reference to voluntary contributions along with loan repayments, did Congress mean to say that voluntary contributions are not “reasonable and necessary” expenses? The court in Parks decided that the “hanging paragraph” excludes only pre-petition contributions from disposable income. The Drapeau court finds otherwise and concludes that post-petition contributions are excluded from disposable income.
To bolster their statutory interpretation, Drapeau and its predecessors acknowledge that Congress intended BAPCPA to bolster retirement savings, especially in light of dwindling employer sponsored defined benefit plans. See, eg., In re Bruce, 2012 WL 6138228, *2, Bankr W.D. Wash 2012.
Does it matter whether the debtor is above-median or below-median?
Yes and no. Virtually all courts that have considered the issue conclude that a below-median debtor is not precluded from excluding his voluntary 401k contributions. The split appears to be confined to cases filed by above-median debtors.
Courts and commentators have also pointed to the inequity of disallowing voluntary contributions for employees in the private sector, while many public sector employees are allowed to deduct mandatory contributions to state retirement plans. See, eg., In re Bruce, 2012 WL 6138228, *2, Bankr W.D. Wash 2012.