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Bankruptcy Exemptions: Protecting Retirement Accounts

By Columbia – Lexington Bankruptcy Attorney Lex Rogerson

retirement accounts - optimizedIn this second of a series on debtor-friendly Supreme Court decisions, we focus on a 2005 opinion that protected IRA’s from bankruptcy trustees.

If you’ve paid any attention to retirement planning in the last 30 years, you’ve noticed that the conventional defined-benefit pension plan has become an endangered species. Increasingly, workers are having to fund their own retirement plans through individual retirement arrangements (IRA’s), 401(k) plans, SEP’s, Keoghs, and so on.  So when the U.S. Supreme Court decided that IRA’s fit within the Bankruptcy Code exemption that protects certain retirement accounts, it preserved the primary means of financial security in later life for thousands of people who are forced to file bankruptcy.  Rousey v. Jacoway, 544 U.S. 320 (2005). And it became part of a movement that has now resulted in protection of virtually all retirement plans.

The Rouseys’ case

Richard and Betty Jo Rousey of Berryville, Arkansas, both worked for Northrup Grumman Corp., where they were covered by an employer-sponsored pension plan.  When they left Northrup, they were both forced to take lump-sum distributions from their pensions, and they rolled these funds into separate IRA accounts at First National Bank. In 2001, they filed a chapter 7 bankruptcy case and claimed the IRA’s as exempt under section 522(d)(10)(E) of the Bankruptcy Code. That provision protects the debtor’s rights in “a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of illness, disability, death, age, or length of service.”

The trustee, Jill Jacoway, objected to the exemption, claiming that an IRA is not “similar” to pension plans and the like and that, because the Rouseys had complete control over their IRA funds, the plans were not “on account of” any of the factors listed in the statute. The bankruptcy court agreed with the trustee and disallowed the exemption, as did two higher appeals courts. The Supreme Court agreed to hear the Rouseys’ appeal and unanimously reversed all the lower courts.

The Court first held that the debtor’s right to IRA funds is “on account of” age because the funds can only be withdrawn without penalty after the owner reaches 59-1/2 years of age. The court then concluded an IRA is “similar” to a pension, annuity, etc., because it is intended to provide a post-retirement substitute for earnings from employment. Therefore, the exemption statute applied, and Jacoway could not seize the funds from the Rouseys’ IRA’s.

Why it matters

On the most direct and literal level, this decision is less important than it first appears. The Bankruptcy Code allows states to opt out of the exemptions in section 522(d).  32 states have opted out, leaving the provision at issue in Rousey applicable only in the remaining 18 states (plus DC, Puerto Rico, and the Virgin Islands).

Indirectly, however, Rousey is much more important than this.  In the first place, many states have exemptions patterned on 522(d)(10)(E).  For example, South Carolina, an opt-out state, has enacted an exemption virtually identical to the federal one. So while debtors in South Carolina can’t claim the federal exemptions, Rousey stands as highly persuasive authority that this state’s provision means the same thing.

Even more importantly, the Supreme Court opinion is part of a broad momentum, mostly on the legislative front, toward explicit protection of IRA’s and other non-traditional retirement arrangements.  South Carolina has expressly exempted IRA’s since 1999. A few days after the decision was announced, Congress added an exemption for all tax-exempt retirement plans, and that provision applies even in opt-out states.  These laws now protect virtually all retirement arrangements an employer or a worker would want to set up.

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