June 23, 2005
INTRODUCTION. On April 4, 2005, the United States Supreme Court handed down its decision in Rousey v. Jacoway, a case addressing the issue of exempting individual retirement accounts (IRAs) from federal bankruptcy proceedings. The decision was widely hailed in the financial press, with such headlines as “High Court Rules IRAs Untouchable - Unanimous Decision Means Retirement Savings Are Protected From Creditors” (Wall Street Journal, April 5, 2005, p. D1). Unfortunately for the public, the headlines did not accurately reflect the underlying story, but this issue of APN will clarify the holding.
BACKGROUND. The federal Bankruptcy Code permits a debtor to exempt certain property from his bankruptcy estate, thereby allowing him to retain those assets rather than divide them among his creditors. Under current federal bankruptcy law (which may change soon) these exempt assets are determined either under the Bankruptcy Code or under the law of the state of residence of the person filing the bankruptcy petition (the “petitioner”). The determination of which set of laws apply in a particular case is determined under state law. Some states permit the petitioner to choose either the federal or the state provided exemptions, some states primarily rely on the federal exemptions, and some states preclude the petitioner from using the federal exemptions.
In 2001, at the time of filing their joint bankruptcy petition and several years after they had deposited distributions from their pension plans into their respective IRAs, Richard & Betty Jo Rousey were resident in Arkansas.
"The Rousey case only applies to bankruptcy filings in states which either require the use of the federal exemption scheme or which permit their residents to choose the federal scheme. The case has no application in states like Florida, for example, which preclude the use of the federal exemption related to IRAs."Arkansas law allows petitioners to choose the federal or state exemptions in a bankruptcy proceeding. The Rouseys chose the federal exemptions. Here’s how the case wound up in the Supreme Court: They sought to shield portions of their IRAs from their creditors by claiming them as exempt from the bankruptcy estate under a provision of the Bankruptcy Code (11 U.S.C. § 522(d)(10)(E)), which provides, among other things, that a debtor may exempt from the bankruptcy estate his "right to receive ... a payment under a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of ... age." Ms. Jacoway, the Bankruptcy Trustee (whose job is to enhance the bankruptcy estate for the benefit of the petitioner’s creditors), objected to the Rouseys' exemption claim and asked the Bankruptcy Court to turn over the IRAs to her. The Bankruptcy Court agreed with her objection and granted her motion, and the Bankruptcy Appellate Panel (BAP) also agreed. The Eighth Circuit affirmed, concluding that, even if the Rouseys' IRAs were "similar plans or contracts" to the plans specified in §522(d)(10)(E), 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.
SUPREME COURT. In its detailed analysis of the statute, the Supreme Court found that the Rouseys' right to receive payment under their IRAs must meet these requirements to be exempted: (1) the right to receive payment must be from "a stock bonus, pension, profitsharing, annuity, or similar plan or contract" and (2) the right to receive payment must be "on account of illness, disability, death, age, or length of service". If the foregoing requirements are met, then the right to receive payment may be exempted only "to the extent" that it is "reasonably necessary to support" the accountholder or his dependents (this last element was buried deep in the Wall Street Journal article). The dispute between the bankruptcy trustee and the Rouseys in the case was over the two listed elements. The Supreme Court noted that it had already implied that IRAs satisfy those elements in Paterson v. Shumate, a case discussed by us 13 years ago in APN Vol. I, No. 2 (Sept. 1992), and it went on to analyze those requirements in great detail. The court reiterated its discussion of this issue in Patterson and found: that IRAs are exempt, and sent the case back to the lower court to determine the amount reasonably necessary for support as required by the statute.
CONCLUSION. IMPORTANT: The Rousey case only applies to bankruptcy filings in states which either require the use of the federal exemption scheme or which permit their residents to choose the federal scheme. The case has no application in states like Florida, for example, which preclude the use of the federal exemption related to IRAs. In addition, if Rousey does apply in a particular case, it can only result in the exemption of that portion of the IRA which is "reasonably necessary to support" the accountholder or his dependents. Thus, a very a substantial portion of a large IRA would likely be exposed.