by A chapter 13 debtor’s post-petition contributions to his qualified retirement account may be deducted from the calculation of his projected disposable income and the amount of those contributions is presumed to be the average contribution made during the six months preceding bankruptcy. Where, as here, the debtor substantially increased his contributions on the eve of bankruptcy, he bears the burden of proving that his projected disposable income calculation should be reduced by the increased retirement account contributions. In re Huston, 2021 WL 4528883 (Bankr. N.D. Ill. Sept. 30, 2021) (case no. 20-81689).
The above-median debtor was 50 years old, divorced with no children, owned a house with approximately $40,000 in equity and, in the six months prior to filing for bankruptcy, grossed $7,561.00 in wages. One week prior to filing for bankruptcy, the debtor increased his monthly contributions to his 401(k) plan from $324.75 to $1,495, thereby substantially reducing the amount of income available for paying to unsecured creditors. At trial, the debtor explained that he increased his 401(k) contribution on the advice of his bankruptcy counsel, and in order to provide for his future. He identified no anticipated changes in health, employment or financial condition in the future, and expected to retire at age 65 or 70.
The trustee objected to confirmation of the plan under section 1325(a)(3) on the grounds that the debtor failed to commit all of his projected disposable income, and that the plan was proposed in bad faith.
The court began its analysis with section 541(b)(7) which excludes from property of the estate contributions by the debtor to an employee retirement benefit plan. To that provision, Congress added a “hanging paragraph” providing, “except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).” After noting incongruities between “property” and “income” in the provision, as well as the nonsensical “except that” at the beginning of the hanging paragraph, the court went on to look at how this provision has been interpreted.
Some courts, like Parks v. Drummond (In re Parks), 475 B.R. 703 (B.A.P. 9th Cir. 2012), have interpreted the provision narrowly to find that no post-petition contributions to retirement accounts may be excluded from monthly income. Courts such as Baxter v. Johnson (In re Johnson), 346 B.R. 256 (Bankr. S.D. Ga. 2006), take the broad view that any and all retirement account contributions may be excluded from income. And finally, representing the middle ground, courts such as Penfound v. Ruskin (In re Penfound), 7 F.4th 527 (6th Cir. 2021); and Davis v. Helbling (In re Davis), 960 F.3d 346 (6th Cir. 2020), hold that so long as the contributions pre-date the petition date, they may continue during the plan and not be included in the debtor’s disposable income calculation. Within the courts adopting the middle ground approach, some look to the average of contributions made in the six months prior to filing for bankruptcy while others look only to the amount being contributed on the petition date.
The court here was persuaded that the middle ground approach was most suitable and went on to adopt the reasoning in In re Ahn-Thu Thi Vu¸ No. 15-41405-BDL, 2015 WL 6684227 (Bankr. W.D. Wash. June 16, 2015), where that court took the average contributions in the six months preceding bankruptcy as the amount to deduct from disposable income.
The court rejected the narrower reading as adopted in Parks, noting that, unlike other parts of section 541, section 541(b)(7) does not contain a temporal limitation. The court further opined that the phrase “such amount,” in the hanging paragraph refers to a category of funds rather than the specific retirement fund contributions made prior to filing for bankruptcy. It therefore disagreed with Parks’s reasoning that the phrase was intended to allow a debtor to exclude only the amount contributed pre-petition. Moreover, Parks’s limitation to pre-petition contributions makes little sense in light of the fact that those contributions do not represent post-petition income and would therefore never be included in the disposable income calculation. The court went on to discuss and reject interpretations of sections 1306, 1322(f), and 707, on which some courts adopting the narrow view have relied.
Having rejected the narrow approach under which no post-petition contributions are excluded from disposable income, the court went on to explain its adoption of the approach taken by the Ahn-Thu court. “This court agrees with In re Anh-Thu Thi Vu that section 541(b)(7) does exclude post-petition contributions, but because section 541(b)(7) refers to ‘disposable income as defined in section 1325(b)(2)’ and not more broadly to ‘projected disposable income,’ this court must further conclude that the analysis should begin with a calculation based on the average six-month pre-petition income, excluding only average contributions made within that period.”
To the extent that the debtor’s “projected disposable income” may differ from the disposable income calculation due to the debtor’s increased retirement plan contributions, the court referred to the good faith requirement codified in section 1325(b)(3) as protection against a debtor’s attempt to “game the system.” Noting that some courts have held that mere increase in retirement account contributions does not necessarily lead to a finding of bad faith, the court, here, found that, “where a debtor proposes a lower plan payment based on increased retirement plan contributions rather than the average disposable income reflected in the six-month current monthly income period, the burden will be on the debtor to justify the deviation from the presumptive showing of disposable income under the means test.”
The court turned to the question of whether the debtor committed his projected disposable income to the plan. Because he filed his petition in September, 2020, the court did not include any income from that month in the initial mechanical calculation of disposable income. Nor did it include the increased retirement account contribution. The court found the debtor’s average disposable income to be “$1,422, which consists of his gross average monthly income of $7,561 minus average monthly 401(k) contributions of $324.75 minus $5,814.25 in expense deductions.”
The court rejected the debtor’s argument that his projected disposable income should be reduced by $1,173.43/month to reflect his future monthly 401(k) contribution amount. The court noted that doing so would decrease recovery by unsecured creditors from 88% to 15%. The court was persuaded that the debtor had not carried his burden of showing entitlement to the increased deduction for several reasons, including: he is a single earner with no dependents, owns his home, has no health issues, is 50 years old and plans to work until age 65 or longer, and he raised his retirement contributions on the eve of bankruptcy.
The court concluded that “the Debtor has not established that his ‘projected’ disposable income is materially different from his disposable income as calculated pursuant to the means test and deducting average monthly contributions to his employer retirement plan during the current monthly income period.” For that reason, the court sustained the trustee’s objection to confirmation and ordered the debtor to file a new plan consistent with its findings.