On Feb. 15, 2012, the Sixth Circuit Court of Appeals handed down an important ruling in the bankruptcy case Seafort v. Burden. The reasoning behind Seafort could have implications for anyone considering bankruptcy, but still looking to grow an adequate retirement fund.
An Overview Of Chapter 13 Bankruptcy
Generally, there are two types of bankruptcy for consumers, Chapter 7 and Chapter 13. In order to understand the Seafort ruling, a grasp on Chapter 13 bankruptcy (and how it differs from Chapter 7) is a must — and you don’t have to be a Highland Chapter 13 bankruptcy lawyer to build a basic comprehension.
Chapter 7 (sometime referred to as “liquidation”) is what many people first think of when they hear the term “bankruptcy.” Chapter 7 involves an almost immediate discharge of debt. Some debtors in Chapter 7 will have to forfeit large assets to partially repay creditors before the discharge. But, contrary to popular belief, Chapter 7 does not always involves a forced sale of your possessions: exemptions mean things like equity in your home, retirement benefits, family heirlooms and other items of property valued up to a certain amount cannot be touched.
Chapter 13 bankruptcy, on the other hand, involves a court-approved consolidation of debts and gradual repayment over time, with a discharge of most or all remaining debt at the end of the repayment term. Chapter 13 is sometimes called a “wage earners plan,” and it does not include liquidation. A Chapter 13 repayment plan lasts for three to five years, during which time a certain portion of your income will be paid to a bankruptcy trustee, who in turn makes distributions to creditors.
In a Chapter 13 bankruptcy, individuals agree to a court-approved plan to pay creditors out of their “disposable income.” What constitutes disposable income varies on a case by case basis; it is your income after required payroll deductions minus the amount necessary to support yourself and your dependants (to pay for food, housing, clothing, etc.).
There are a handful of specials exclusions to disposable income. For instance, charitable contributions up to 15 percent of your gross income may be subtracted from your disposable income, if you run a business, amounts necessary for operating expenses are excludable from disposable income, and certain benefits (like Social Security payments) may be entirely exempt from the calculation of disposable income. While Chapter 13 plans do not always require you to contribute the full amount of your disposable income, if the trustee of your plan or an unsecured creditor objects, your plan can only be confirmed by the court if you contribute all projected disposal income during the repayment term.
Seafort Court Says Freed Up Income Cannot Be Allocated To 401(k) Contributions
The Seafort ruling only pertains to Chapter 13 bankruptcies. In the case, the appellants were going through Chapter 13 bankruptcy, and as part of their Chapter 13 repayment plans, they were repaying 401(k) loans. At the time they filed bankruptcy petitions, none of the appellants were making contributions to their employer-sponsored 401(k) retirement plans.
Well before the end of their repayment plan terms, the appellants were projected to have their 401(k) loans fully repaid. At that point, they proposed that the income made available by repayment of the 401(k) loans be contributed directly to their 401(k) retirement accounts.
However, their Chapter 13 trustee objected to this arrangement. Because the appellants were not contributing anything to their 401(k) retirement plans at the time their bankruptcy cases began, she claimed that the income freed up by repayment of the 401(k) loans qualified as disposable income, and must therefore be used to increase their Chapter 13 repayment plan payments (to be distributed to their unsecured creditors).
The court ultimately agreed with the assessment of the Chapter 13 trustee, finding that voluntary 401(k) contributions were not a deduction from income required for employment. Thus, discretionary amounts freed up by repayment of the appellants’ 401(k) loans had to be applied to their unsecured debts.
What Does Seafort Mean For You?
Seafort is an important case, but it should not be understood as an end-of-the line assessment for any similarly situated bankruptcy filers. For one thing, it only carries precedential value in the Sixth Circuit; elsewhere, the case’s reasoning may be persuasive, but it is not binding. Furthermore, Seafort could yet be the subject of further appeals. And, the bankruptcy filers who were the subject of Seafort were not contributing to their 401(k) retirement plans at the time they submitted bankruptcy petitions — had they been, there is an argument that the outcome could have been very different.
What Seafort does go to show is that bankruptcy is a constantly evolving area of the law, and you need to stay abreast of the latest changes in order to hang on to more of the resources you need to build a solid future. If bills are piling up, don’t wait to contact a bankruptcy attorney. Putting off a hard look at your finances could prevent you from taking advantage of many favorable bankruptcy strategies that are only available early in the process. Get in touch with a bankruptcy attorney today to learn more.