6th Circuit Not Having it With 401(k) Bankruptcy Loopholes

Penfound v. Ruskin, No. 19-2200 (6th Cir. 2021)
Newly established retirement contributions not shielded in bankruptcy

“This picture reminds me of why I’m moving my assets to crypto” says someone annoying, probably.

Dated: August 10, 2021
Recommended for Publication
Affirming

Editor’s Note: This is not first time EZ QDRO Law has blogged about federal appeals court rulings concerning protections from (and exemptions for) the assignment of retirement accounts. Check out Jordan’s write up of a 1st Circuit decision earlier this year to find out how even spouses’ marital property rights can be affected in matters involving criminal fines or restitution.

As readers of this blog know, the protections against assignment (voluntary or otherwise) conferred on retirement assets under the Internal Revenue Code are robust. As readers might also know, debtors in bankruptcy proceedings may even seek to exclude their continuing voluntary retirement contributions from their income, for purposes of such proceedings.

What readers of this blog might not know (don’t worry, the 6th Circuit kind of had to think about it, too) is what happens when a debtor starts contributing to his/her retirement account immediately prior to petitioning for bankruptcy.

In this case, a petitioner contributed historically to an employer-sponsored 401(k), but stopped when he began working for an employer that did not provide one. He resumed such contributions after he began working for a third company nearly at the same time he and his wife filed for bankruptcy. The petitioners sought to exclude his newly established regular contributions from their disposable income (and creditors’ indirect reach).

The Court’s ruling laments that the most relevant and controlling legal authority in such matters, the 1995 Bankruptcy Abuse Prevention and Consumer Protection Act, includes an infamous “hanging paragraph” which it describes as “inelegantly drafted” (perhaps the darkest insult in an appeals court’s arsenal, and said to carry the power to curse entire legislative bodies).

Indeed, no fewer than four competing interpretations of the hanging paragraph have emerged, each of which presents its own interpretive difficulties.

The Court goes on to outline each interpretation under which the petitioners might argue for the exclusion of the husband’s contributions from their disposable income, and explains why their case is different.

Toward the end, the Court addresses the petitioners’ argument that a 6-month ‘look-back window’ was imposed without justification, and that it should consider contributions much longer before then, in deciding whether to include or exclude them in petitioners’ disposable income. The Court rejected this argument, and affirmed the lower court’s ruling.

Blog Posts are intended to bring attention to developments in the law and are not intended as legal advice for any particular client or any particular situation. Please consult with counsel of your choice regarding any specific questions you may have.