401(k) Deferrals Protected in Bankruptcy

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Ernie Guerriero, CLU®,ChFC®,CEBS,CPCU®,CPC®,CMS,AIF®,RICP®,CPFA

A recent court case, decided June 1, 2020, is interesting in protecting 401(k) deferrals in bankruptcy.  If a 401(k) Plan is available to an employee and the employee has been making deferrals, those deferrals are not considered “disposable income” for bankruptcy purposes.

A divided panel of the Sixth Circuit (Ohio, Michigan, Kentucky and Tennessee) has determined that where a Chapter 13 debtor had been making contributions to her employer’s 401(k) plan well before her bankruptcy filing, the debtor could exclude those payments from her projected disposable income, thus shielding them from her unsecured creditors. [In re Davis (2020, CA6) 2020 WL 2831172] 

With Chapter 13 bankruptcy, more assets can be protected than with a Chapter 7, and that means life insurance policy of whatever type should be safe. Key word, “should be”.  However, the cost of premiums might impact your disposable income and expense considerations.  With Chapter 7 bankruptcy, what’s important is the available cash surrender value of a universal or whole life policy. It’s also important to know whether you have minor children the policy is designed to protect and whether you have available exemptions to cover the amount.

Why is this important?  The life insurance in a Qualified Plan is protected with continued deferrals to the individual’s 401(k) Plan.  State Bankruptcy Laws may or may not protect or may have conditions applied to life insurance policies.  For example; in New York there is a complete exemption of accelerated death benefits, cash surrender and/or loan value, and dividends against claims of policyowner’s creditors.  However the exemption is inapplicable if debtor actually receives cash loan value and has full control over funds.  In California, $15,650 exemption against execution pursued by judgment creditor applies to loan value of unmatured policy, it may be doubled if the debtor is married.  And in Florida, the cash value of life insurance policy insuring Florida resident or citizen may not be attached by creditor of insured.

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