Supreme Court Determines IRAs Exempt from Bankruptcy Estate

April 11, 2005 ( - The US Supreme Court has overturned lower court rulings for a case in which a couple was trying to shield their IRA accounts from access by creditors after filing for Chapter 7 bankruptcy.

Richard and Betty Jo Rousey claimed their IRAs were exempt from the bankruptcy estate under the provision that states that a debtor may with­draw from the estate his “right to receive . . . a payment under a stock bonus, pension, profit sharing, annuity, or similar plan or con­tract on account of . . . age,” according to the court opinion.   The Bankruptcy Court, agreeing with the Bankruptcy Trustee’s objection, ordered the IRAs turned over to her, and the Bankruptcy Appellate Panel agreed.

The 8th US Circuit Court of Appeals affirmed the bankruptcy court’s decisions, saying that, even if the Rousey’s IRAs were “similar plans or contracts” to the plans specified in the provision, their IRAs gave them no right to receive payment “on account of age,” but were instead savings accounts readily acces­sible at any time for any purpose, the opinion said.

In its opinion, the Supreme Court said the IRAs do provide a right to payment “on account of age” since the Rouseys would suffer a 10% penalty if they withdraw from their accounts prior to age 59 ½. The court said the 10% was substantial and prevents access to the 10% if the Rouseys were to withdraw early.

Further, the court determined that the IRAs were similar to the plans listed in the provision, saying they represent income that substitutes for wages lost upon retirement.   The court said that the similarity is demonstrated by the following facts:

  • Regulations require distribution to begin no later than the calendar year after the year the accountholder turns 70½;
  • Failure to take the requisite minimum distributions results in a 50% tax penalty on funds improperly remaining in the account;
  • Taxation of IRA money is deferred until the year in which it is distributed; and
  • Withdrawals before age 59½ are subject to the 10% penalty.

The lower court rulings were reversed and remanded by the Supreme Court.   The opinion is  here .