Soon to be Unemployed Executive Contemplates Bankruptcy

I received the following email from a gentlemen who lives in Kentucky.  I believe that he found my Atlanta bankruptcy blog and submitted his question to me through the blog contact form.  I asked the gentleman if I could answer his question with a blog post and he agreed. The question is long and has multiple parts - hopefully some of my colleagues in the Bankruptcy Law Network will add their thoughts as well:

Here is the question:   Jonathan, I’m being laid off.  My last day is December 31, 2007.  I earn 120K per year.  My 401K totals 95K and I owe about 30K in loans against it.

My wife and I have five children.  The median income for a family of 7 in KY is about $7,500.  If I don’t land a comparable job within a month or two we are going to be in a real bind.  If I earn $2k in January and February our six month average will drop to $7,333, just low enough to qualify us for a Chapter 7 I think.

When I leave I’m contemplating rolling my 401K into a series of smaller IRAs that I can cash out as needed.  But I’m not even sure the 401k will be available if the 30K in outstanding loans are not paid. Here come the questions:

Can I access the 401K at all without paying off the 40K in loans?  The rules I’ve seen seem to indicate the loans must be paid before the 401K is released.  Assuming the loans are paid and I can roll the remaining $65K into a series of IRAs (I don’t want to expose the whole amount to bankruptcy creditors if it comes to that) does it make any sense to tap into those IRAS (after paying the penalties) to keep the family afloat while I search for another job?

Will the money from the IRAs I have to cash in be treated as income for purposes of calculating our median income?

Currently, I make payments on the 401K loans totaling approximately $550.  In calculating our median incom prior over the prior six months can those payments be deducted?

Finally, we have approximately $950 in deferred student loan payment that come due in January.  Are those payements deductible if we file in March?

And is there any hope that any portion of the $100K+ in student loans will be discharged?

Thanks for any thoughts / insights you might have.

Here are my thoughts:

1.  I am not a Kentucky lawyer.  I believe that federal courts (including bankruptcy courts) are controlled by 6th Circuit federal law.  Georgia is in the 11th Circuit and frequently there are differences among the federal judicial circuits about how laws are to be interpreted.   I will make some general suggestions but you need to seek out local counsel to advise you about your specific situation.  This disclaimer, by the way, applies to any answer you see on the Bankruptcy Law Network blogs.

2. Median income calculation - if you wait until March, 2008, the six month lookback for median income purposes would be September, 2007 - February, 2008.  Using this time period, your six month average would fall below the median income in Kentucky for a family your size.  I agree with your logic.  Two other questions to ask - (1) some bankruptcy courts allow you to rebut the presumption of bad faith (over median income) if your employment situation has changed - if that applies here you would not have to wait; and (2) even if you get past the median income test, a Chapter 7 trustee could argue “bad faith” on the grounds that your earning capacity is in the $120,000 range and that it would not be fair to allow you to obtain a Chapter 7 discharge during a short period of unemployment.

2. Rollover IRA issue - I don’t know if a bankruptcy filing would change the rules of your 401(k) issuer and thereby allow you to roll your company 401(k) into individual IRA’s without repaying the loan.   Perhaps my Bankruptcy Law Network colleagues can weigh in on this issue.

3.  Use of IRA’s - the question to ask is whether your IRA’s (or 401(k)) is exempt property in the bankruptcy court where you would file your case.  In Georgia, IRA’s are basically exempt in total.  As such, I almost always advise my clients not to tap their IRA’s since these assets are protected from creditors.  You need to find out if qualified retirement vehicles like IRA’s and/or 401(k) plans are similarly protected in Kentucky.  I would try to find this out prior to making any conversion.

4. Is an IRA distribution income for median income test purposes?  I believe that any such distribution would be included in your median income calculation.

5. Deductibility of 401(k) loan payments for means test purposes.  Here in Georgia, these loan payments cannot be deducted for means test purposes.  Remember, however, that if your income is below the median, you don’t need to reach the means test at all.

6. Deferred student loan payments - here, too, you don’t need to worry about means test calculations if your median income is below the State median.  If you are above the median, you need to find out whether student loan payments are allowable means test deductions.

7. Discharge of student loans - not very likely.  See my post about discharge of student loans in bankruptcy.