In most circumstances, you can borrow from your 401(k) to repay a loan. However, that’s not usually the case with a Michigan chapter 13 bankruptcy. The only exceptions are a permission from the court or a condition of your employment.
First, How Does a 401(k) Work?
A 401(k) is an employer-sponsored retirement plan in which a certain amount of your income is deposited. In many cases, the employer contributes a certain amount as well. If you sign up for the automatic deduction, the money is deducted before tax time. Thus, it simultaneously builds your retirement fund and lowers your tax liability.
What’s the Difference Between a Chapter 13 and a Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is filed as complete collateral for your debt. Chapter 13 is the interest bankruptcy. It involves repaying interest in full or on a plan to the bankruptcy trustee.
Can You Borrow From Your 401k while in Chapter 13?
Most attorneys and financial experts don’t recommend withdrawing from your 401(k) during a Chapter 13 bankruptcy. There are a lot of penalties plus the apparent reduction in your retirement savings.
Second, 401(k) money is considered exempt from bankruptcy. If it’s converted into cash before the filing, however, it loses its exemption status. As a result, bankruptcy trustees can’t even take it. Still, that can be a tough one to pull.
However, it’s recommended to use the cash before filing to avoid liquidation of your assets if that option is used. It’s also a bad idea to withdraw more money than the debtor can afford to exempt.
There’s yet another reason that most experts answer no in most cases to the question of whether 401k withdrawal for Chapter 13. It has to be approved by the court because it’s illegal to use it for monthly payments. It’s considered trying to save money at the expense of the creditors. That’s expected to come from the individual’s disposable monthly income.
What’s Disposable Income?
In this context, disposable income is the money that the individual has left over after bills, vehicle maintenance, food, and other needs. You can work out a plan with your bankruptcy trustee. However, having extremely high expenses won’t get you out of the responsibility for paying the debt. The bankruptcy laws, not you, determine what’s reasonable.
Why is 401k Withdrawal for Chapter 13 Such a Complicated Matter?
Unfortunately, whether you’re allowed to withdraw from your 401(k) to pay off a Chapter 13 depends on the court. Some don’t consider it necessary at all and won’t allow it under any circumstances whatsoever.
Others work it out on a case-by-case basis. Those who do will allow it only if it’s exceptional and see that you don’t have any excessive spending habits.
The courts’ biggest concern is that you won’t be able to support yourself when you retire. If you can’t, that means that your Social Security will be your only income, and you will have to rely on Medicare. Neither one covers everything.
What About Involuntary Contributions? Can 401k Be Taken in Bankruptcy Then?
If your employer requires you to take a specific chunk out of your retirement fund to stay with the company, this is allowed in most cases. In this case, it’s a reduction in your disposable income because it’s going directly to the source of your income.
However, if you pay your retirement loan off before the end of the expected Chapter 13 repayment period, you may have to increase your payment plan.
The Michigan bankruptcy attorneys at Moran Law can answer all of your questions about bankruptcy. We will help you reclaim control of your finances and get the fresh start you deserve.
