We have a contractual right of setoff against a loan customer with a deposit account at our bank that receives Supplemental Security Income (SSI) and pension payments. We have been freezing the pension payments as soon as they hit the account and leaving the protected SSI payments alone. However, there’s more money in the account that has been sitting there since before the customer defaulted and our right to setoff arose. How can we determine which account funds can be setoff and which are protected when the funds are commingled? Can we follow the “lookback” provisions for garnishment of federal benefit payments, or should we only offset funds going forward that we know are not protected? Also, do the same procedures apply to other government benefits, such as social security?

We do not believe it is possible to distinguish SSI or other protected funds from unprotected funds once they have been commingled, and we do not believe the guidance on garnishing federal benefit payments is applicable to a contractual right of setoff. Consequently, we recommend only offsetting unprotected funds at the time of deposit, when you are able to discern from their ACH coding whether they are designated as protected federal benefit payments.

The regulations addressing the garnishment of accounts containing federal benefit payments (such as SSI and social security benefits) allow financial institutions to distinguish protected federal benefits from unprotected funds using a two-month “lookback period,” during which the sum of all benefit payments posted to the account are considered protected, and any funds exceeding that amount can be garnished. The lookback period is triggered by the receipt of a “garnishment order,” defined as “a writ, order, notice, summons, judgment, levy or similar written instruction issued by a court, a State or State agency, a municipality or municipal corporation, or a State child support enforcement agency.” Consequently, since a contractual right of setoff does not arise out of a written instruction from a court or government agency, we do not believe the lookback period can be applied in the context of a right of setoff.

Additionally, the law is not well settled with respect to whether federal benefit payments can be setoff. In 2002, a federal bankruptcy court in Illinois held that a credit union could not use social security deposits to offset a customer’s loan obligation, since Section 407(a) of Social Security Act prohibits the assignment of federal benefits and was intended by Congress as “a broad bar against the use of any legal process to reach all Social Security benefits.” Although the U.S. Supreme Court held in 2007, that “legal process” as it is used in Section 407(a) should be understood to “require utilization of some judicial or quasi-judicial mechanism,” subsequent Illinois case law has recognized only a narrow exception for offsetting overdraft and similar account fees from an account containing social security deposits.

Since we are not aware of any Illinois authority allowing the use of government benefits to offset a debt unrelated to the account holding the benefits, we do not believe the SSI benefits in your customer’s account should be setoff. Additionally, we note that while the case law deals with social security benefits, we believe the holdings apply to SSI benefits, which are afforded the same protections as social security benefits under Section 407(a), and in some contexts (such as exemption from child support garnishment) greater protections.

As such, we recommend continuing your current practice of offsetting unprotected funds as they are deposited into your customer’s account. For reference, the Treasury Department’s guidelines for identifying protected government benefits by their ACH code are included in the resources below.

For resources related to our guidance, please see:

31 CFR 212.2(b) (“This part applies to . . . Federal benefit payments protected from garnishment pursuant to the following authorities: (1) SSA benefit payments protected under 42 U.S.C. 407 and 42 U.S.C. 1383(d)(1) . . .”)

Social Security Act, 42 USC 407(a) (“The right of any person to any future payment under this title shall not be transferrable or assignable, at law or in equity, and none of the moneys paid or payable or rights existing under this title shall be subject to execution, levy, attachment, garnishment, or other legal process or to the operation of any bankruptcy or insolvency law.”)

Social Security Act, 42 USC 1383(d)(1) (“The provisions of section 407 of this title and subsections (a), (d), and (e) of section 405 of this title shall apply with respect to this part to the same extent as they apply in the case of subchapter II.”)

Social Security Act, 42 USC 1381 (“For the purpose of establishing a national program to provide supplemental security income to individuals who have attained age 65 or are blind or disabled, there are authorized to be appropriated sums sufficient to carry out this subchapter.”)

31 CFR 212.3 (“Lookback period means the two-month period that begins on the date preceding the date of account review and ends on the corresponding date of the month two months earlier, or on the last date of the month two months earlier if the corresponding date does not exist.”)

31 CFR 212.5(c) (“Benefit payment deposited during lookback period. If the account review shows that a benefit agency deposited a benefit payment into the account during the lookback period, then the financial institution shall follow the procedures in § 212.6.”)

31 CFR 212.6 (“The following provisions apply if an account review shows that a benefit agency deposited a benefit payment into an account during the lookback period.

(a) Protected amount. The financial institution shall immediately calculate and establish the protected amount for an account. The financial institution shall ensure that the account holder has full and customary access to the protected amount, which the financial institution shall not freeze in response to the garnishment order. An account holder shall have no requirement to assert any right of garnishment exemption prior to accessing the protected amount in the account.

(b) Separate protected amounts. The financial institution shall calculate and establish the protected amount separately for each account in the name of an account holder, consistent with the requirements in § 212.5(f) to conduct distinct account reviews.

(c) No challenge of protection. A protected amount calculated and established by a financial institution pursuant to this section shall be conclusively considered to be exempt from garnishment under law.

(d) Funds in excess of the protected amount. For any funds in an account in excess of the protected amount, the financial institution shall follow its otherwise customary procedures for handling garnishment orders, including the freezing of funds, but consistent with paragraphs (f) and (g) of this section.”)

31 CFR 212.5(a)(1) (“Timing of account review. When served a garnishment order issued against a debtor, a financial institution shall perform an account review: (1) No later than two business days following receipt of (A) the order, and (B) sufficient information from the creditor that initiated the order to determine whether the debtor is an account holder, if such information is not already included in the order . . .”)

31 CFR 212.3 (“Garnishment order or order means a writ, order, notice, summons, judgment, levy or similar written instruction issued by a court, a State or State agency, a municipality or municipal corporation, or a State child support enforcement agency, including a lien arising by operation of law for overdue child support or an order to freeze the assets in an account, to effect a garnishment against a debtor.”)

In re Brewer, No. 02-32068, 2002 Bankr. LEXIS 992, at *8-9 (Bankr. S.D. Ill. Aug. 15, 2002) (“This Court finds that a reading of the plain language of 42 U.S.C. § 407(a) leads to the conclusion that an individual cannot enter into an agreement which, in effect, assigns the individuals rights to any future payment of Social Security benefits. The Supreme Court stated, in Philpott vs. Essex County Welfare Board, 409 U.S. 413, 34 L. Ed. 2d 608, 93 S. Ct. 590 (1973), that, when it passed § 407 of the Social Security Act, Congress ‘imposed a broad bar against the use of any legal process to reach all Social Security benefits.’ The Supreme Court further affirmed that Social Security benefits, even when converted to ‘funds on deposit that are readily withdrawable retain the quality of monies within the purview of § 407.’”)

In re Brewer, No. 02-32068, 2002 Bankr. LEXIS 992, at *9 (Bankr. S.D. Ill. Aug. 15, 2002) (“In the case presently before the Court, there is no dispute that the funds which the Credit Union seeks to offset against pre petition debt of the Debtors are directly traceable to the Social Security benefits of the Debtors. This being the case, the Court concludes that 42 U.S.C. § 407(a) prohibits the action contemplated by the Credit Union regardless of the prior agreement of the Debtors that the subject funds would act as collateral for their loans from the Credit Union.”)

Wash. State Dep’t of Soc. & Health Servs. v. Guardianship Estate of Keffeler, 537 U.S. 371, 385 (2003) (“Thus, ‘other legal process’ should be understood to be process much like the processes of execution, levy, attachment, and garnishment, and at a minimum, would seem to require utilization of some judicial or quasi-judicial mechanism, though not necessarily an elaborate one, by which control over property passes from one person to another in order to discharge or secure discharge of an allegedly existing or anticipated liability.”)

Wilson v. Harris N.A., No. 06 C 5840, 2007 U.S. Dist. LEXIS 65345, at *29-32 (N.D. Ill. Sep. 4, 2007) (A bank does not violate Section 407 of Social Security Act “by collecting an overdraft fee from funds on deposit, whenever those funds originated from a monthly Social Security payment. . . . Notably, other courts have concluded that § 407 does not prohibit a bank from using Social Security funds to pay overdraft fees pursuant to a voluntarily-entered account agreement.”)

Office of Child Support Enforcement, Garnishment of Supplemental Security Income Benefits, DCL-13-06 (February 27, 2013) (“Because SSI is a means-tested program that is not based on remuneration for employment, SSI benefits authorized under title XVI of the Act are exempt from child support garnishment and income withholding. To qualify for means-tested benefits, the recipient must have a financial need because he or she earns little to no income and has few resources. Additionally, the recipient must also be at least 65, blind, or disabled.”)

Department of the Treasury, Guidelines for Garnishment of Accounts Containing Federal Benefit Payments (March 2020), pages 3–4 (“These guidelines apply to the following federal programs: . . . Social Security and Supplemental Security Income benefits administered by the Social Security Administration . . . In addition, these guidelines apply only to federal benefits paid electronically via the ACH. Financial institutions are not responsible for examining accounts to identify federal benefits paid by Treasury check.”)

Department of the Treasury, Guidelines for Garnishment of Accounts Containing Federal Benefit Payments (March 2020), page 5–6 (“Treasury/Fiscal Service will encode an ‘XX’ in Positions 54-55 of the ‘Company Entry Description’ Field and a ‘2’ in the ‘Originator Status Code’ Field of the Batch Header Record for ACH/PPD and ACH/CCD payments that are designated as federal benefit payments that are exempt from garnishment. This encoding will allow financial institutions to determine whether a federal direct deposit payment is an exempt federal benefit payment. Financial institutions may rely on the presence of an ‘XX’ encoded in Positions 54-55 of the ‘Company Entry Description’ Field and a ‘2’ in the ‘Originator Status Code’ Field of the Batch Header Record of a direct deposit entry to identify a federal benefit payment exempt from garnishment.”)