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Proof that a 401(k) is ERISA qualified. An ERISA qualified 401(k) is exempted or protected in bankruptcy. ERISA is an acronym for Employee Retirement Income Security Act. ERISA is a federal law setting the minimum protection standards for individuals contributing to pension and some health plans established by private companies. ERISA does not apply to federal and state employees, since they are usually government retirement plans.

Most retirements plans meet the ERISA requirement. Sources for this information: the employer may have a letter on file from the IRS, or the 401(k) administrator (ask them to provide you a copy of the plan summary), or review the plan summary online. In the table of contents, there may be a section that speaks about ERISA. Again, most employer sponsored 401(k) plans meet the requirements under ERISA. However, it is something should be verified prior to filing bankruptcy. Often the bankruptcy Trustee will ask for a copy of the most recent 401(k) statement and a notice of ERISA qualification prior to the meeting of creditors.

Hebbring v. U.S. Trustee, No. 04-16539 (9th Cir. September 11, 2006) The Bankruptcy Code does not, per se, disallow voluntary contributions to a retirement plan as a reasonably necessary expense in calculating a debtor’s disposable income, but rather requires courts to examine the totality of the debtor’s circumstances on a case-by-case basis to determine whether retirement contributions are a reasonably necessary expense for that debtor.

In re Parks, No. 11-1366 (9th Cir. BAP, Aug. 6, 2012), the Bankruptcy Appellate Panel of the 9th Circuit ruled that Chapter 13 debtors cannot continue to make payroll contributions to a retirement plan during Chapter 13 bankruptcy period. For the last few years, the bankruptcy courts around the country have been divided over whether Chapter 13 debtors can continue to make voluntary contributions to a retirement plan during the Chapter 13 repayment period. See also In re Jenkins, No. 11-16960 (Bankr. E.D. Tenn. July 5, 2012) (same result)


(9/2013)  The BAP ruled  that voluntary 401k contributions are not allowed deductions in the means test in chapter 13.  In re Parks, 475 B.R. 703 (BAP 9th Cir. 2012)  But, the debtor in Parks appealed to the 9th Circuit and then there was a stipulation to dismiss the Parks appeal.  So there is no 9th Circuit opinion.

Judge Curley stated that she was not bound by a BAP ruling and said she might not agree with Parks.  First, the 9th Circuit has never held that a BAP ruling is binding precedent. This is particularly so because Parks was not from the District Of Arizona. This court is free to reach its own conclusion.

Second, Parks ignores the plain wording of the “hanging paragraph” at the end of Section 541(b)(7)(A) that payroll deductions for retirement plans are not  part of disposable income.

(A) withheld by an employer from the wages of employees for payment as contributions–

(i) to–
(I) an employee benefit plan that is subject to title I of the Employee Retirement Income Security Act of 1974 or under an employee benefit plan which is a governmental plan under section 414(d) of the Internal Revenue Code of 1986;
(II) a deferred compensation plan under section 457 of the Internal Revenue Code of 1986; or
(III) a tax-deferred annuity under section 403(b) of the Internal Revenue Code of 1986;

except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2). . . . (emphasis added)

The starting point for statutory interpretation is a review of the language used by Congress in the current version of the law. See Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 438 (1999). Where the text is plain, the court is to apply the statute as written, unless the application would lead to absurd results. Lamie v. U.S. Trustee, 540 U.S. 526 (2004). The clear language of a bankruptcy statute obviates any need to refer to legislative history to interpret it.  Patterson v. Shumate, 504 U.S. 751, 112 S.Ct. 2242, 119 L.Ed.2d 2519 (1992). In his concurring opinion in Patterson, Justice Scalia noted the strange “phenomenon” of going beyond the plain meaning of a statute:

The phenomenon  calls into question whether our legal culture has so far departed from attention to text, or is so lacking in methodology for creating and interpreting text, that it no longer makes sense to talk of “a government of laws, not of men.” 504 U.S. at 766.

Third, the average of contributions made to the 401(k) during the six months prior to filing must be excluded from income in calculating “current monthly income” and in turn from the calculation of “disposable income” under 11 U.S.C. §1325(b)(2), as provided in 11 U.S.C. § 541(b)(7(A)(i). This reading of § 541(b)(7)(A)(i) was not argued by the debtor in Parks. See  In re Bruce, #11-40939, Bankr. W.D. Wash. 12/11/12. If CMI is reduced as required by the statute, then so is disposable income.

Fourth, the debtor will owe additional income taxes if he does not make 401k contributions. Yet, contrary to the 401k issue, the trustee has insisted that the debtor either reduce his tax withholding or turnover tax refunds. See  Paragraph 3, above. The debtor has agreed to turnover refunds. If  the debtor cannot make 401k contributions, then he might not receive any refunds and he might owe taxes during the plan, thereby causing the plan to fail.

See In re Bruce, 11-40939-BDL (WD WA 2013) (Parks not followed) “In summary, this Court accepts Parks’s holding that under § 541((b)(7)(A) only prepetition 401(k) contributions are excluded from property of the estate and therefore only prepetition contributions are excluded from disposable income as defined in § 1325(b)(2). But this Court further holds that the “except that” clause at the end of § 541(b)(7)(A)(i) excludes prepetition contributions from the calculation of CMI if such contributions were made in the six-month look-back period. If 401(k) contributions are deducted from the debtor’s income during that six-month period prepetition, they are not disposable income “as that term is defined in section 1325(b)(2),” and the monthly average of the contributions during that period must be deducted in the calculation of disposable income.”

In re James L. DALEY, 459 B.R. 270 No. 10–34110 (US Bankruptcy Court, E.D. Tennessee.) Oct. 11, 2011.
Background: Chapter 7 trustee objected to exemption claimed by debtor for his interest in individual retirement account (IRA), on theory that debtor had engaged in prohibited transaction that disqualified the IRA from tax exempt status.
Holdings: The Bankruptcy Court, Richard Stair, Jr., J., held that:
(1) issuance of favorable determination letter by the Internal Revenue Service (IRS) on tax exempt nature of individual retirement account (IRA) into which debtor’s funds had been rolled over created only a rebuttable presumption that the IRA was tax exempt, and trustee could introduce evidence to contrary;
(2) by expressly agreeing in Client Relationship Agreement that he signed when IRA was established that brokerage firm with which he opened the IRA would have lien against account for any payment obligations that he had to firm, debtor engaged in prohibited transaction that disqualified the IRA from tax exempt status; and
(3) debtor could not rely on “safe harbor” provision of Code to exempt IRA, on theory that he was not “materially responsible” for IRA’s failure to be in substantial compliance with applicable requirements of the Internal Revenue Code.

In re Daniels ___ B.R. ___ (Bankr.Mass 2011) HELD: IRA not exempt because of numerous failures to comply with IRS Code
In this case the Chapter 7 trustee challenged the debtor’s claim of exemption of funds in a profit-sharing plan and an IRA. The court held that the debtor’s handling of the plans failed to comply with applicable IRS regs and accordingly were not valid under the IRS Code, and therefore not exempt per 11 U.S.C. § 522(b)(1) et seq. The requirements differ depending on whether the IRS has issued a “favorable determination letter.” In this case, the funds failed to qualify under either option.

The debtor and his family were actively involved in managing the funds. Among other things, the court found:
• The debtor managed the funds for his own benefit;
• Transferred non-exempt funds from the profit-sharing plan to the IRA;
• The fund never received a Favorable Determination Letter;
• Conducted prohibited transfers of funds to a disqualified person;
• Rented real property to a family member, a prohibited act;
• Loaned funds to his daughter, a prohibited act;
• Invested Profit-sharing funds into a business venture in which the Debtor had also individually invested.

The IRS prohibits such conduct between the fund and a disqualified person. Among the disqualified persons are “fiduciaries.”
“A “fiduciary” is defined as any person who:
(A) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,
(B) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or
(C) has any discretionary authority or discretionary responsibility in the administration of such plan.109

Additionally, “Prohibited transactions” include the following:
(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;
(B) lending of money or other extension of credit between a plan and a disqualified person;
(C) furnishing of goods, services, or facilities between a plan and a disqualified person;
(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or
(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

The Debtor has admitted that he routinely used the funds in his retirement account to enrich the interests of his family and other disqualified persons, and it is evident from these admissions that executing taxable “prohibited transactions” was the routine manner by which he managed the assets held in his Profit Sharing Plan. Furthermore, having actively managed the affairs of the plan as employer, manager, and trustee of the Profit Sharing Plan, the Debtor was materially responsible for the failure of the plan to be in substantial compliance with applicable tax law. The Debtor has abused the profit sharing plan form and the consequence is that the funds held therein may not be exempted from the bankruptcy estate.

In re Willis __ B.R. __ Bankr. S.D.Fla. 2009) HELD: IRA not exempt because of extension of credit between funds. In this case the debtor’s IRA did receive an IRS Favorable Determination letter. Nevertheless, the court found the IRA not exempt. “The issue before the Court is the propriety of Mr. Willis’ claims of exemptions for the full value of the Merrill Lynch IRA, the Fidelity IRA, and the AmTrust IRA pursuant to § 522(b)(3)(C).” “Movants argue that Mr. Willis is a disqualified person who engaged in prohibited transactions, the effect of which was to disqualify the Merrill Lynch IRA for exemption from taxation, and consequently disqualify the IRA from bankruptcy estate exemption under § 522(b)(3)(C).

“Movants contend that Mr. Willis engaged in prohibited transactions under § 4975 when: 1) Mr. Willis borrowed and used funds from the Merrill Lynch IRA to acquire assignment of the Ocean One Property Mortgage from Southwest, 2) Mr. Willis borrowed funds from the Merrill Lynch IRA in order to engage in a check- swapping scheme to cover a shortfall in the Joint Brokerage Account, and 3) Ocean One borrowed funds from the Merrill Lynch IRA to acquire the Ocean One Property Mortgage from Southwest.

“Under § 4975(c)(1)(B), any direct or indirect lending of money or other extension of credit between a plan and a disqualified person constitutes a prohibited transaction. In this case, Movants presented evidence at trial that Mr. Willis borrowed funds from the Merrill Lynch IRA to purchase the assignment of the Ocean One Property Mortgage from Southwest.

“In December 1993, Mr. Willis withdrew $700,000 from the Merrill Lynch IRA to purchase the assignment of the Ocean One Property Mortgage. On or about February 22, 1994, Mr. Willis returned $700,000 into the Merrill Lynch IRA. “Consequently, the Court finds that Mr. Willis engaged in a prohibited transaction under § 4975(c)(1)(B) by borrowing $700,000 from the Merrill Lynch IRA to acquire the assignment of the Ocean One Property Mortgage from Southwest.

“Therefore, as a result of Mr. Willis’ prohibited transaction under § 4975(c)(1)(B), the Merrill Lynch IRA ceased to be an exempt IRA under § 408 of the IRC as of January 1, 1993. “For the reasons stated above, the Court determines that the following funds are not exempt from the bankruptcy estate under § 522(b)(3)(C): 1) all funds in the Merrill Lynch IRA, 2) all funds in the AmTrust IRA, and 3) $60,000 in the Fidelity IRA.

The court also cited In re Hughes 293 B.R. 528 (Bankr.M.D. Fla. 2003) ” … concluding that debtor’s IRA was not exempt from the bankruptcy estate because debtor engaged in a § 4975(c)(1)(B) prohibited transaction by withdrawing $27,000 from his IRA to lend to a corporation for which he was the principal and subsequently returning the funds to the IRA)”; and Zacky v. Comm’r, 2004 WL 1172874 (T.C. May 27, 2004)(determining that a § 4975(c)(1)(B) prohibited transaction occurred when disqualified person caused plan to loan funds to companies for which he was the president and sole shareholder.”

HOWEVER, the issue doesn’t stop there. The circumstances in the two cases cited above appear to relate to retirement programs more likely associated with self-employed individuals than the more typical wage-earner employer funded IRA.

However, there may be a problem even with employer-sponsored IRAs if typical or standard agreements with brokerage firms contain tainted language. This appears to be the subject of a recent Labor Department memorandum issued in response to a question put by California attorney Tim Berry:

In 2009 Berry asked the U.S. Department of Labor to give an advisory opinion on the validity of a clause in a brokerage firm’s agreement granting the firm a security interest in the IRA funds.

” … whether it would be a prohibited transaction … for an IRA owner to grant to a brokerage firm a security interest in the assets of his non-IRA accounts held by the Broker as a requirement for establishing an IRA with the Broker. “It is the opinion of the Department that the grant by an IRA owner to the Broker of a security interest in his non-IRA accounts in order to cover indebtedness of, or arising from, his IRA, as you describe, would be a prohibited transaction under Code section 4975(c)(1)(B).

“Section 4975(c)(1)(B) prohibits the direct or indirect lending of money or other extension of credit between a plan and a disqualified person. The granting of a security interest in the IRA owner’’s personal accounts to cover indebtedness of, or arising from, the IRA constitutes such an extension of credit.
“Nevertheless, the Department notes that to the extent that the situation you describe also would result in the granting by the IRA owner to the Broker of a security interest in the IRA’’s assets to cover the indebtedness of the IRA owner, prohibited transactions would likewise occur in violation of Code sections 4975(c)(1)(B), (D), & (E) …”

SIMILAR QUESTIONS were the subject of a more recent DOL opinion letter, also involving the IRA owner’s control of, and benefit from, the IRA assets: ” … Mr. Warfield, as the IRA owner who has sole discretion to direct the investments made by his IRA, would be a fiduciary and a disqualified person with respect to the IRA under Code section 4975(e)(2) and would be subject to the restrictions imposed by section 4975(c)(1). Ms. Warfield, as Mr. Warfield’’s wife, would be a disqualified person with respect to the IRA as a ““member of the family”” of the IRA fiduciary. The Family Trust would also be considered a disqualified person under section 4975(e)(2), since Mr. Warfield is its trustee and the Warfields are its sole beneficiaries.”

The US Supreme Court [official website] ruled unanimously in Clark v. Rameker, (U.S., June 12, 2014) (case no. 13-299) held that an inherited IRA is not exempt under Code § 522(b)(3)(C) or § 522(d)(12) because the funds in an inherited IRA are not “retirement funds” within the meaning of those provisions.  Section 522 of the Bankruptcy Code exempts tax-exempt retirement funds from the bankruptcy estate. In October 2010 the Clarks filed voluntary joint bankruptcy and claimed an inherited IRA under the Section 522 exemption, to which the bankruptcy trustee and creditors objected. The district court ruled that inherited IRAs are exempt because they retain their character as retirement funds, but the US Court of Appeals for the Seventh Circuit reversed that ruling.  The Supreme Court agreed with the Seventh Circuit: “the possibility that some investors may use their inherited IRAs for retirement purposes does not mean that inherited IRAs bear the defining legal characteristics of retirement funds. Were it any other way, money in an ordinary checking account (or, for that matter, an envelope of $20 bills) would also amount to “retirement funds” because it is possible for an owner to use those funds for retirement.”

But see: In re Thiem, Bktcy Ct AZ 1/19/2011 – Arizona law protects IRA assets from a beneficiary’s creditors after the original owner’s death, provided the account is treated as an inherited IRA.  As stated above, the Supreme Court in Clark v. Rameker ruled that an inherited IRA is not protected in a bankruptcy case, but the Supreme Court did not specifically address whether a conflicting state statute might change the result.  Therefore, at least for now, the Arizona statute protects an Arizona resident’s inherited IRA assets from creditors seizure, including if the beneficiary files for bankruptcy protection.

NOTE: Unlike an IRA, an inherited 401(k) does not become estate property.  In re Dockins, 20-10119 (Bankr. W.D.N.C. June 4, 2021)  Judge Hodges (N.C. Bankruptcy judge) distinguished Clark. There, the question was whether an inherited IRA fell under Section 522(b)(3)(C), which exempts “retirement funds” if they are exempt from taxation under specified provisions of the Internal Revenue Code. Clark focused on the characteristics of inherited IRAs that make them something other than “retirement funds.” Unlike retirement funds, the holder of an IRA cannot make additional investments, must continually make withdrawals, and may withdraw everything without incurring a penalty.

Judge Hodges observed that inherited 401(k)s have “the same legal characteristics,” but the result was not the same. Unlike IRAs, the trusts holding 401(k)s must have anti-alienation provisions as required by both the IRS Code and ERISA.

In re Kara, No. 16-51059 (Bankr. W.D. Tex. July 13, 2017)  The interpretation in Clark v. Rameker of the federal exemption relating to inherited IRAs does not preclude a state from providing a broader exemption for inherited IRAs in its exemption scheme.

When Waheeda Kara filed for chapter 7 bankruptcy she opted to use Texas state exemptions and claimed an exemption in an inherited IRA under section 42.0021 of the Texas Property Code. The trustee objected to the exemption arguing that it did not meet the criteria set forth in Clark for an exemptible “retirement fund.” The court found that state exemptions permitted her to exempt the IRA and overruled the objection. In re Kara, No. 16-51059 (Bankr. W.D. Tex. July 13, 2017).

In re Scott Lee Egebjerg, 574 F.3d 1045 (9th Cir., Aug. 3, 2009), page 147 (case no. 08-55301) The Ninth Circuit Court of Appeals has issued an opinion amending and superseding In re Egebjerg, 2009 WL 1492138, Bankr. L. Rep. ¶ 81,498 (9th Cir., May 29, 2009), although the new opinion does not change the outcome. The Ninth Circuit held that a debtor’s obligation to repay a loan from his or her retirement account is not a “debt” and are not “an actual monthly expense for the categories specified as “Other Necessary Expenses” issued by the IRS under §707(b)(2)(A)(ii), and thus is not a secured debt; that the repayment obligation not an “other necessary expense”; and that the repayment obligation is not a special circumstance, although there may be situations in which the debtor’s underlying reason.

see also McVay v. Otero (In re Otero), 371 B.R. 190 (W.D.Tex 2007) (held pension loan repayments were not payments on account of a secured debt); Eisen v. Thompson (In re Thompson) 370 B.R. 762 (N.D.Ohio 2007) (held pension loan repayments were not payments on account of a debt);

401K loans are not debts. Like life insurance loans, they reduce the value of the asset. Repayment is never mandatory.

(19) under subsection (a), of withholding of income from a debtor’s wages and collection of amounts withheld, under the debtor’s agreement authorizing that withholding and collection for the benefit of a pension, profit-sharing, stock bonus, or other plan established under section 401, 403, 408, 408A, 414, 457, or 501(c) of the Internal Revenue Code of 1986, that is sponsored by the employer of the debtor, or an affiliate, successor, or predecessor of such employer-

(A) to the extent that the amounts withheld and collected are used solely for payments relating to a loan from a plan under section 408(b)(1) of the Employee Retirement Income Security Act of 1974 or is subject to section 72(p) of the Internal Revenue Code of 1986; or

(B) a loan from a thrift savings plan permitted under subchapter III of chapter 84 of title 5,

that satisfies the requirements of section 8433(g) of such title;

but nothing in this paragraph may be construed to provide that any loan made under a governmental plan under section 414(d), or a contract or account under section 403(b), of the Internal Revenue Code of 1986 constitutes a claim or a debt under this title;

Cunning v. Rucker, No. 08-55652 U.S. 9th Circuit Court of Appeals, June 26, 2009
In an appeal from the Bankruptcy Court’s order denying an exemption for Debtor’s assets in pension and 401(k) plans, the order is affirmed, where the retirement plans were not designed and used primarily for retirement purposes. Facing a civil judgment debt of more than $6.5 million, Lloyd Myles Rucker declared bankruptcy and tried to exempt his assets as belonging to private retirement plans under California Civil Procedure Code (“CPC”) § 704.115. Rucker had previously placed the assets in pension and 401(k) plans funded by his wholly owned corporations. The bankruptcy court denied the exemption on the explicit ground that Rucker’s retirement plans were not designed and used primarily for retirement purposes. The district court reversed, but 9th Circuit upheld bankruptcy court.

“If your stocks are part of a retirement plan under section 401(a), 403(a), 403(b), 408, 408A or 409 or a deferred compensation plan under section 457 of the United States internal revenue code of 1986, as amended, whether the beneficiary’s interest arises by inheritance, designation, appointment or otherwise, then the stocks are exempt from all claims of creditors of the beneficiary or participant. Two exceptions, any funds contributed in the 120 days prior to filing, and if you are subject to a QDRO.” Thomas Cesta, Mesa bankruptcy attorney, 11/12

CHAPTER 13: a trustee may object in a 13 to voluntary contributions, but this is a case by case situation (the older debtor is seen more favorable to save for retirement than the younger debtor). The guidelines cite to 11 USC 541(b)(7)(B). See 11 USC 541 (b)(7)(B) and it states ERISA and Section 414, Section 457 and Section 403(b) plans are all protected (nothing is mentioned about voluntary 401k contributions).

Most likely the argument could be made that because you don’t count 401k contributions towards the means test definition of disposable income, you should not be able to count them for actual disposable income. You could cite In re Ronald Mills, 99-07826, Southern District of CA, (while a Chapter 7 decision, it analyzes 11 USC 1325), stating: Here, the debtor attests that he has no other retirement savings plan, that he is 56 years old, and that he desires to continue funding his qualified 401(k) plan with 10% of his salary, approximately $302 per month. As of the petition date, the balance in the plan is only $9,000, so this is clearly not an instance where the debtor has accumulated substantial amounts of equity in a retirement plan, which he desires to continue padding at the expense of his creditors. Cf. In re Watkins, 216 B.R. at 396 ($1,099 monthly retirement fund contribution is not reasonably necessary); cf. also In re Fountain, 142 B.R. at 137. Moreover, a review of the debtor’s schedules indicates very modest budgeting on all scores. Based upon this evidence, the court concludes that under § 1325(b)(2)(A), this debtor is permitted to deduct as a reasonably necessary expense, the 10% voluntary contribution to his qualified 401(k) plan. In these circumstances, there is no reason to conclude that providing a modest amount of contribution to a 401(k) plan is not reasonably necessary for the maintenance and support of this debtor.

Determine if the retirement plan is a IRA or a 401k/pension?  Only an IRA is property of the bankruptcy estate upon filing (at least in Arizona).  An IRS qualified 401k or pension is not property of the bankruptcy estate (federal exemption).

The issues identified above add to a growing list of questions that may arise in a case involving claims of exemptions for IRAs and similar retirement accounts, including issues arising under state laws. See; In re Segovia 404 B.R. 896 (N.D.Cal. 2009) (whether fund was “primarily” intended for retirement purposes); In re McDonald __ B.R. __ (Bankr.ID 2008) and In re Cutignola __ B.R. __ (Bankr.S.D.N.Y. 2011) (inherited IRA); In re Beverly 314 B.R. 221 (9th Cir. BAP 2007) (rolled over from non-exempt benefit plan).

First, make sure the retirement plans is qualified under the Internal Revenue Code.  If so, exempt under §522(a)(3)(C) and any applicable state exemption.  If Trustee objects to the exemption and include a memorandum of points and authorities:

  1. The Trustee has the burden of proof on objections to exemptions, and he/she has failed to carry that burden by failing to state the reasons for his/her objection, F.R.Bankr.P. 4003(c) (also check local rules); and
  2. Support the Debtors’ claim of exemption is absolutely correct under §522(a)(3)(C).

Also review Jackson v. Gray (In re Gray), 523 B.R. 170 (9th Cir. BAP 2014), which states, based upon dicta in Law v. Siegel, 571 U.S. 415, 134 S. Ct. 1188, 188 L. Ed. 2d 146 (2014), (no time limit for debtors to amend exemptions, nor is there a bad faith exception to allowing debtors to amend their claims of exemptions).

My thanks to Arnold Wuhrman, The Wuhrman Law Firm, for his suggestions.