Many debtors who find themselves in cash flow problems borrow from their 401(k), and then there are very rigid repayment obligations to these 401(k) loans. In fact, the Bankruptcy Code specifically says that 401(k) loan repayments are permitted and are to be deducted from your gross income to figure out what your net disposal income figure is going to be when you repay your creditors. At the end of your loan repayment period, you’re done. What you’ve been doing is you’ve been repaying money that you borrowed from yourself. So theoretically, you’re preferring yourself over your creditors when you repay your 401(k) loans. And even though that’s something that is generally frowned upon in the Chapter 13 world, it’s specifically authorized in the Bankruptcy Code.
What happens when you’re done with your 401(k) loan repayment, and it’s during that five-year Chapter 13 repayment period? The general rule is that once you’re done with your 401(k) loan repayment you can’t resume 401(k) loan deductions from your paycheck. Again, this is because you’re paying yourself before you’re repaying your creditors. That’s not allowed under Chapter 13. So some courts have been saying “we’re going to look at what you were deducting before you filed for bankruptcy, and we’re going to let you resume those deductions from your payroll.” But these courts are in the minority. Most courts say until you’re done with your five-year Chapter 13 repayment period, if you’re not paying your creditors in full, you’re going to have to pay all of your net disposal income for the benefit of your creditors, and that would include any money that you would otherwise want to set aside into your 401(k) plan.
