Ninth Circuit Joins Consensus: 401k Loans Not Deductible As Secured Debt Under Means Test

Joining what has become the consensus position, the Ninth Circuit has held that payments on a 401k loan may not be deducted under the chapter 7 means test. Egebjerg v. Anderson, 2009 U.S. App. LEXIS 11651 (9th Cir. 5/29/09). The opinion highlights a major inconsistency in the way that BAPCPA treats retirement plan loans.

The Ninth Circuit ruled that a loan from a retirement plan was not a debt and therefore was not a secured debt which could be deducted on line 42 of the means test. The crux of the ruling is found in the following language:

The reasoning behind these decisions is straightforward. Egebjerg’s obligation is essentially a debt to himself — he has borrowed his own money. (citation omitted). Egebjerg contributed the money to the account in the first place; should he fail to repay himself, the administrator has no personal recourse against him. (citation omitted). Instead, the plan will deem the outstanding loan balance to be a distribution of funds, thereby reducing the amount available to Egebjerg from his account in the future. (citation omitted). This deemed distribution will have tax consequences to Egebjerg, but it does not create a debtor creditor relationship.

Opinion, pp. 6386-87.

In my view, this is an area where the law has gone astray. I recently received a loan from my 401k plan. The document which I signed was entitled "Loan Agreement, Note and Pledge." In pertinent part, the document stated:

For value received the Borrower agrees to pay the Lender the amount of $________ principal and interest at an annual interest rate of ______%. The length of the loan shall be ___ months. Payment shall be made to the Trustee of the Plan in the amount of $_______ Semi-Monthly beginning ______ and ending _______. Prepayment of the unpaid principal and accrued interest may be made by the Borrower at any time without penalty.

Pledge to secure this loan: Borrower hereby irrevocably pledges his/her vested account balance under the Plan in satisfaction of any unpaid balance and associated costs due and payable upon default.

Thus, there is a Lender, a Borrower, a promise to pay and a security interest. The fact that the security interest is in funds contributed to a retirement plan should not make a difference. While the funds in the retirement plan originated from my contributions, they are no longer under my dominion and control. If I buy 1 share of Berkshire Hathaway and then borrow money secured by that stock, I have in essence borrowed my own money; my money has just taken the form of Berkshire Hathaway stock instead of cash. The pledge of the stock allows me to keep my money in the form of the stock while having access to it through the intermediary of the bank. The analogy of a pledge of stock is particularly appropriate, since I have the assets in my 401k plan invested in mutual funds.

Besides ignoring the form and substance of the transaction, the consensus position is inconsistent with the manner in which 401k loans are treated elsewhere by BAPCPA. BAPCPA included three provisions specifically aimed at protecting retirement plan loans. Section 362(b)(19) provides that retirement plan loans are not subject to the automatic stay, thus allowing their continued collection in a bankruptcy case. Section 523(a)(18) provides that a "debt" owed to a retirement plan is non-dischargeable, thus protecting a debtor from tax liability resulting from discharge of the loan. Finally, Section 1322(f) provides that a retirement plan "loan" may not be altered by a chapter 13 plan and may not be included in calculation of the debtor's disposable income. There are two important points here. The first is that since the Code refers to these obligations as "debts" and "loans" in other places, why would they not be a debt or a loan under the means test? Secondly, the purpose of the chapter 7 means test is to identify debtors who can afford to pay their debts under a chapter 13 plan. Therefore, it makes logical sense to interpret the chapter 7 means test in light of what would be deductible in a chapter 13 case.

Unfortunately, it looks like the train has left the station on this issue and the Ninth Circuit's position does reflect a consensus among courts. As a result, this may be an issue requiring a legislative fix.