Today in 2005: SCOTUS rules IRAs may be exempt from bankruptcy estates

April 4, 2014

Today in Legal HistoryThe Supreme Court often rules in cases that, while perhaps not particularly significant to the general public or even to the majority of attorneys and other legal professionals, are nonetheless significant milestones in a specific area of law.

The Court ruled in such a case in Rousey v. Jacoway, handed down nine years ago today, on April 4, 2005. In Rousey, the Court held that IRAs are eligible for exemption from bankruptcy estates.

The facts of the case begin with the petitioners, Richard and Betty Jo Rousey, who were formerly employed at Northrup Grumman Corp.  When they were terminated from their employment, Northrup Grumman required them to take lump-sum distributions from their employer-sponsored pension plans, which the Rouseys then deposited into two IRAs, one in each of their names.

Several years after the establishment of their IRAs, the Rouseys filed a joint Chapter 7 bankruptcy petition in which they sought to shield the assets in their IRAs from the reach of creditors.

The court-appointed Chapter 7 Trustee, Jill R. Jacoway, objected to the exemption claim, and moved for turnover of those assets to her.

The bankruptcy court sustained Jacoway’s objection and granted her motion.  The Rouseys appealed, but the Bankruptcy Appellate Panel agreed with the bankruptcy court.  The Rouseys once again appealed, but the Eighth Circuit Court of Appeals affirmed.  The Supreme Court agreed to hear the case.

In a unanimous decision written by Justice Clarence Thomas, the Court reversed the Eighth Circuit; the appeals court held that such accounts were not exempt from the bankruptcy estate because the petitioners were not limited to receiving payments from their IRAs “on account of age.”

Receiving payments “on account of age” is relevant here because section 522(d)(10) of the U.S. Bankruptcy Code allows debtors to exempt certain assets from the bankruptcy estate – thereby shielding those assets from the reach of creditors.

Subsection (E) of these exemptions allows a debtor to shield “a payment under a stock bonus, pension, profitsharing, annuity, or similar plan or contract” that is made “on account of illness, disability, death, age, or length of service.”

The court of appeals found that the IRAs were indeed “similar plans or contracts,” but that, since the assets in the accounts could be accessed at any time before the age of 59 ½ subject to a 10% tax penalty, the IRAs were more like a savings account.

The Supreme Court disagreed with this proposition, instead holding that the 10% tax penalty for early withdrawal was substantial, contrary to Jacoway’s contention.  Further, the Court found that because the 10% penalty applies proportionally to any amounts withdrawn, it effectively prevents access to the entire balance in the Rouseys’ IRAs.

Because this condition is removed once the accountholder turns 59 ½, “the Rouseys’ right to the balance of their IRAs is a right to payment ‘on account of’ age.”

Although you may never read about Rousey in law school outside of a course on bankruptcy, nor will you likely ever find yourself citing to the nine-year-old case in a brief if you aren’t a practicing bankruptcy attorney, the case remains nevertheless significant for those practicing within that field.

After all, the Court ruled that IRAs, a very commonly-used retirement account, may be exempt from creditors’ claims in a Chapter 7 bankruptcy proceeding.

It may not be Citizens United v. FEC or U.S. v. Windsor, but Rousey is still an important Supreme Court ruling.