You can use your 401k payroll deduction to reduce your chapter 13 plan payment dollar for dollar. It may be hard to believe, but you may be part of the community who has excess income for bankruptcy purposes. Excess income is determined in the following ways:
The good-faith income test
In a chapter 13 the good-faith test is determined by your net income. Net income is figured by subtracting your monthly expenses listed in schedule J of the bankruptcy petition from your net monthly income from schedule I. You must remember that your monthly expenses are reduced by items that will be paid by the trustee through your plan such as car payments, and mortgage payments if you are behind. This resulting positive number will be your plan payment.
The means test to determine monthly disposable income
No doubt you have heard about the means test. What most people do not understand is that there are different means tests for chapter 7 and chapter 13. In a chapter 13 case it is necessary to complete the entire means test analysis even though you may be under the Ohio median income. The reason for this is that the final number in the means test is a calculation of the monthly amount you should be paying to your unsecured creditors.
Saving for retirement and filing for bankruptcy
Somewhere along the line a court decided that if you were unable to pay your bills you should not be allowed to save for your retirement. Your unsecured creditors should not bear the brunt of funding your retirement. If you are not paying your bills you cannot subtract a 401k payroll deduction from income in determining whether a chapter 7 case is proper. In the real world this means that if you have a 401k payroll deduction, or loan payment you cannot include them on schedule I of your chapter 7 bankruptcy petition. This rule could result in the good-faith income test requiring you to file the other chapter. Further, there is no provision in the Chapter 7 means test to reduce your income for payments into retirement plans.
If you pay your creditors you can save for retirement at the same time
When you file a Chapter 13 you can reduce income on both schedule I and the means test by the amount you contribute to qualified retirement plans. In general this means payroll deductions for both 401k contributions and loan payments. If you are in an excess income situation, your plan payment can be quite high. You can take advantage of this 401k exception by maxing out your contribution. This results in a dollar for dollar reduction in the amount of money you have to pay on a monthly basis for your plan payment. Instead of a low retirement contribution, with a high monthly payment for your unsecured creditors, you can minimize the amount they receive, and at the same time provide for the future of you and your family.