The Business Department
2005 case says debtors can shield portions of tax-deferred IRA benefits, if certain requirements are met
The United States Supreme Court unanimously ruled on April 4, 2005 in Rousey et ux. v. Jacoway that debtors can shield portions of their tax-deferred Individual Retirement Accounts (IRAs) from their creditors by claiming them as exempt assets under a section of the Bankruptcy Code. This case will significantly impact many Americans, since approximately 1.56 million filed for bankruptcy in 2004 and more than 45 million have IRAs.
As noted by the Supreme Court, the "Bankruptcy Code permits debtors to exempt certain property from the bankruptcy estate, allowing them to retain those assets rather than divide them among their creditors." The debtors in the Rousey Supreme Court case were an out-of-work married couple in Arkansas who filed for Chapter 7 bankruptcy protection in 2001. Under Chapter 7, debtors can wipe out their debts and get a fresh start. The couple was looking to keep more than $55,000 in retirement savings from creditors after they rolled over money into their IRAs from an employer-sponsored pension plan.
Rousey's Impact
As a result of the Rousey decision, IRAs can be given protection under Federal bankruptcy law in the same manner as 401(k)s, pensions, annuities, social security and other benefits that relate to age, illness, disability, death or length of service. However, IRA accounts are only exempted "to the extent" that they are "reasonably necessary to support" the debtor or the debtor's dependents. Therefore, IRA exemptions are still in the discretion of bankruptcy judges, and debtors under forty years of age looking to exempt IRAs could have trouble satisfying this requirement.
In holding that the debtors can exempt their IRAs in bankruptcy, the Supreme Court reversed the judgment of the Eighth Circuit Court of Appeals, which had denied the debtors' claim for exemption of their IRAs. The Court noted that in order for IRAs to qualify as exempt property, the payment must be tied to a person's age and the IRAs must be similar to a stock bonus, pension, profit-sharing, annuity plan or contract. The Court held that a debtor's right to payment from IRAs is connected to their age. Even though an individual can withdraw from his or her IRAs at any time, IRAs are still related to a person's age because a significant tax penalty is imposed on the account holder if that person makes a withdrawal before the age of 60. In addition, the Court concluded that IRAs are similar to the other listed benefits like pensions and annuities because they all share the same general purpose of helping people save for their retirement.
A common feature of all these listed plans is that they all provide income as a substitute for wages earned by hourly compensation or salary. The Trustee in Rousey opposed the debtors' position and argued that IRAs are not similar plans because they are mere savings accounts. However, Justice Clarence Thomas, in writing for the Court, held that "[f]unds in a typical savings account...can be withdrawn without age-based penalty." Justice Thomas further reasoned that even though an account holder for an IRA receives a right to payment on demand, the right is restricted by the 10 percent tax penalty on withdrawals made before the age of 60. As a result, IRAs can qualify as exempt property in a bankruptcy proceeding.MacElree Harvey
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