Is a 401(k) Withdrawal Income in a Bankruptcy?

An important part of the bankruptcy process is determining your income as a debtor. In order to qualify for bankruptcy, you must show the court that your income is insufficient to fund a payment plan to creditors through the use of the "means test." For the purposes of the means test, a withdrawal from your 401k plan is considered income.

Bankruptcy Chapters

• The main types of consumer bankruptcy are Chapter 7 and Chapter 13. A Chapter 7 bankruptcy will preserve your assets under certain exemption levels as defined by the state, and a successful discharge will eliminate most if not all of your debts. With a Chapter 13 bankruptcy, you must commit to making payments to your creditors according to a court-approved payment plan. However, you may keep your assets, even those above your state's exemption levels.

Means Test

• The means test helps determine if you qualify for a Chapter 7 bankruptcy, or if you must file a Chapter 13 bankruptcy. For means test purposes, all of your income over the past six months is divided by six to determine your average monthly income. If your income falls under the median income for a family of your size in your state, you generally qualify for a Chapter 7. However, if your income is over the median and you have over $105.42 in disposable monthly income after all expenses, you may have to file a Chapter 13 bankruptcy and make payments to your creditors.

Significance

• The significance of 401k withdrawals when filing for bankruptcy is that they are included in your income on the means test. As long as you received the funds in the previous six months, you must list the withdrawal on your means test. Depending on your other income, your 401k withdrawal could push you into a Chapter 13 bankruptcy instead of a Chapter 7.

Avoidance

• In order to prevent your 401k withdrawal from showing as income on your means test, you can wait to file your bankruptcy petition. The means test only includes income for the previous six months, so if you can wait to file your petition until after the six-month window, your 401k withdrawal will not be used in the means test calculation.

Considerations

• Most individual debtors prefer to file Chapter 7 rather than Chapter 13 bankruptcy so that they can eliminate all of their debts without making any payments. However, if you have a large amount of assets and the ability to pay at least something to your creditors, you may prefer to file Chapter 13. In this instance, your 401k withdrawal will not work against you since you will not have to qualify for a Chapter 7.