The right to receive IRA proceeds is a right to payment "on account of" age, and therefore can be exempted from a bankruptcy estate under the provision of the Bankruptcy Code that exempts other retirement plans, the court held in Rousey v. Jacoway, 544 U.S. ____ (2005) (No. 03-1407). Justice Clarence Thomas delivered the 14-page opinion of the court,which ruled unanimously.
The case concerned Richard and Betty Jo Rousey, former employees of Northrup Grumman Corp., who took lump-sum distributions from their employer-sponsored pension plans upon termination of their employment, and deposited the sums into IRAs. As with other legally qualified IRAs, the Rouseys’ IRA agreements provided that any withdrawals made before they turn 59-and-a-half, with limited exceptions, were subject to a 10 percent tax penalty. Taxes are deferred until the proceeds are withdrawn, and their "entire interest in the custodial account" must be, or begin to be, distributed in the year they turn 70-and-a-half.
Several years after setting up their IRAs, the Rouseys filed for Chapter 7 bankruptcy, and sought to exempt portions of their IRAs under 11 U.S.C. §522(d)(10)(E), which provides that a debtor may withdraw from the bankruptcy estate his "right to receive—"(E) a payment under a stock bonus, pension, profit-sharing, annuity, or similar plan or contract on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor…" [Italics added.]
The bankruptcy trustee objected and the bankruptcy court sustained the objection. The Rouseys appealed, and the Bankruptcy Appellate Panel upheld the ruling, concluding the IRAs did not qualify as a "similar plan" because by contrast to the limited access permitted to the enumerated plans, the Rouseys had "unlimited access" to their IRA funds, "subject only to a … tax penalty."
The Court of Appeals for the Eighth Circuit affirmed the bankruptcy panel’s ruling, but noted that several other circuits had reached contrary results.
The Supreme Court granted certiorari to resolve the division.
In the court’s opinion, Justice Thomas noted the dispute hinged on whether IRAs qualified as a "similar plan" to those listed, and whether payments from the plan were made "on account of…age."
The bankruptcy trustee argued that because the Rouseys could withdraw their funds at any time, so long as they were willing to pay the 10 percent tax penalty, there was no "causal connection" between the Rouseys’ right to payment and age—distinguishing their IRAs from the other retirement plans listed by the statute.
"We disagree," Justice Thomas wrote. "The statutes governing IRAs persuade us that the Rouseys’ right to payment from IRAs is causally connected to their age."
Congress designed IRAs to preclude early access, and the low rates of early withdrawals are consistent with the notion that the tax penalty is substantial enough to deter early withdrawals, the high court stated.
Because the withdrawal condition is removed when the account holder turns 59 and a half, "the Rouseys’ right of the balance of their IRAs is a right to payment ‘on account of’ age," the court concluded.
Similarly, an IRA can be interpreted to be a "similar plan" to the other listed investment vehicles because they all are designed to replace wage income at retirement age, Justice Thomas wrote.
The opinion did not reach the requirement in subsection (E) that exempt payments must be "reasonably necessary for the support of the debtor and any dependent of the debtor." Should debtors attempt to shield large amounts of money from creditors through IRAs, this requirement could be used to distinguish the holding in Rousey.
This article is presented for informational purposes only and is not intended to constitute legal advice.
