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401K Loans in Chapter 7 Bankruptcy


401K Loans in Chapter 7 Bankruptcy

It is common for a debtor to attempt to solve their debt problems by taking out a loan from their 401k plan only to decide to file Chapter 7 bankruptcy afterwards because those attempts failed. These loans also come with a plan to pay back the loan. These pay back plans are usually mandated by the debtor’s employer.

401k loans are not dischargeable in bankruptcy. In fact, they are not even classified as debt. The Bankruptcy Code defines “debt” and “claim.” A “debt” means “liability on a claim.” A “claim” means a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” A 401K Loan cannot be a debt because in essence it is a debt that the debtor owes to themselves. So, loans from a 401K are not dischargeable because they are not debts.

The problem arises with Chapter 7 qualification and the means test. If the gross income for a debtor (and their spouse if married) does not exceed the means test threshold then the 401k repayment amount does not mean much. However, if gross income does exceed the means test threshold and deductions are used to bring the debtor under the means test the repayment could be a problem. Payment made to repay the loan from the 401k are not deducted from income. It’s money from income to pay yourself back for the loan you took against yourself.

If you are thinking about filing Chapter 7 bankruptcy and you have a 401k that you have taken a loan against it is important to consult a bankruptcy attorney to make sure it will not impact your ability to qualify for Chapter 7 bankruptcy.

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