Can a 401(K) Loan Be Discharged in Bankruptcy?

Posted on January 15, 2015 at 3:47pm by

When people find themselves in financial trouble and needing an extra income boost to be able to pay their mortgage, car loan, student loan or other everyday debts, many find it enticing to borrow from their employer sponsored retirement plan, otherwise known as a 401(k). People finding themselves in a financial pinch may find these loans attractive as they are relatively easy to obtain since there is no cumbersome credit check and the interest rate is often very low. Often times, these loans become a part of the myriad of other debts that are considered when people are forced to file for protection under Chapter 7 or Chapter 13 of the Bankruptcy Code.

It may be tempting to believe that these loans may be discharged along with other debts customarily dischargeable within a bankruptcy, however it is important for a potential filer to understand that this is not the case.

Unlike money borrowed from a typical third-party creditor, when you borrow from your 401(k) plan you are essentially borrowing money from yourself. Consequently, since you are in actuality your own creditor, 401(k) loans will not be considered by the court as debt owed to another and will not be considered as dischargeable.

Additionally, 401(k) loans that are scheduled as being paid off during the life of a Chapter 13 bankruptcy plan may have an effect on your plan payment. The money that has been freed up as a result of the satisfaction of a 401(k) loan may be considered as newly found “disposable income” by the bankruptcy trustee and court. Consequently, that new income may become an asset of the bankruptcy estate that will be distributed to creditors as opposed to a bump in your wallet. Furthermore, if a 401(k) loan or loans are due to be paid off during the life of a Chapter 13 plan it may require that the plan be organized in a bstep-upb fashion, taking into account the dates when the loans are to be paid off and the corresponding increase in plan payments that result.

A 401(k) remains a valuable asset to everyday consumers when planning for retirement and contributions made to a 401(k) are generally exempt from bankruptcy. While this fact remains constant the darling status of a person’s 401(k) in bankruptcy does not absolve one from having to pay back those loans, even in a bankruptcy.

For additional information or to find out the answer to other bankruptcy questions, call The Sader Law Firm and speak with one of our experienced Kansas City bankruptcy attorneys. We offer a free phone consultation at 816-281-6349.