US Supreme Court Extends Bankruptcy Protection to IRAs

April 4, 2005 ( - Ruling in a case involving an Arkansas couple who had rolled over pension distributions into an individual retirement account (IRA), a unanimous US Supreme Court ruled Monday that IRA assets can be protected under bankruptcy laws.

By ruling for Richard and Betty Jo Rousey of Berryville, Arkansas who have been battling to shield more than $55,000 in retirement savings from their bankruptcy estate, the high court extended protections already afforded to pensions, 401(k)s, and Social Security and other benefits tied to age, illness or disability.

Monday’s ruling in  Rousey versus Jacoway is also a significant development in retirement circles because of new rules mandating IRA rollovers. Plans with mandatory distribution provisions now   have to have something in place to deal with distributions of more than $1,000 for which distribution instructions aren’t provided (See  IRS, Treasury Issue Automatic Rollover Guidance ).  Fighting the Rouseys in the current case was bankruptcy trustee Jill Jacoway.

Even though Jacoway contended that the couple’s IRA assets should be included in the money distributed to their creditors, the justices ruled that IRAs should be eligible for special treatment because of the 10% early withdrawal penalty the accounts carry. Jacoway argued that the couple had the right to withdraw IRA funds at any time if they were willing to pay the penalty

“Contrary to Jacoway’s contention, this tax penalty is substantial,” wrote Justice Clarence Thomas, for the court. “The deterrent to early withdrawal suggests that Congress designed it to preclude early access to IRAs. The low rates of early withdrawals are consistent with the notion that this penalty substantially deters early withdrawals from such accounts.”

Lump Sum Distributions

According to the opinion, both Rouseys took lump sum distributions from the Northrup Grumman Corp. pension plan before he took early retirement in 1998 and Mrs. Rousey was laid off a month later. They ultimately rolled the funds over to two separate IRAs. Several years later, the couple filed for Chapter 7 bankruptcy protection in the US Bankruptcy Court for the Western District of Arkansas, asking that the IRA accounts be kept out of their bankruptcy estates from which their creditors would be repaid. The IRA owned by Richard Rousey totaled $42,915.32 at the time of bankruptcy filing while Mrs. Rousey’s IRA totaled $12,118.16 at the time of filing.

Jacoway objected to the request and an Arkansas bankruptcy judge agreed.   The couple appealed the issue to the US 8 th Circuit Court of Appeals, which likewise agreed in September 2002 that the IRAs should be included in the Rouseys’ pool of assets.

“The fact that the debtors have unfettered discretion to withdrawal causes their IRAs to look less like exempt retirement plans and more like non-exempt bank savings accounts with favorable tax treatment,” 8 th Circuit judges ruled. The 8 th Circuit decision is  here . (See High Court to Ponder IRA Bankruptcy Exclusion ).

In Monday’s decision the Supreme Court reversed the lower appeals court and sent the case back for further hearings.