High court to decide if IRAs are protected from creditors

Thursday, December 2, 2004

An Arkansas couple is seeking to keep two retirement accounts after filing for bankruptcy.

By Hope Yen ~ The Associated Press

WASHINGTON -- The Supreme Court considered Wednesday how much retirement savings people can shield when they file for bankruptcy, an important question as more Americans go into debt.

The justices heard arguments in the case of a bankrupt Arkansas couple seeking to keep their two Individual Retirement Accounts.

Bankruptcy law already protects pensions, 401(k)s, Social Security and other benefits tied to age, illness or disability. Most justices appeared reluctant to allow the seizure of all the money in IRAs, a nest egg used by millions of people, though Justice Sandra Day O'Connor offered that some accounts might be taken to repay debts.

IRAs, which can be opened by anyone regardless of employment, allow investors to contribute up to $3,000 annually to a fund that grows tax-free until withdrawals. It is the only retirement plan available to the self-employed, small business owners and workers between jobs.

Unlike many other retirement plans, IRAs permit cash withdrawals for any reason at any time so long as holders 59 1/2 and younger pay a 10 percent penalty tax.

"The statute says the right to receive payment is on 'account of age,"' Justice Anthony Kennedy said. "If a client can take the money out at any time, why is it on account of age?"

But Justice Stephen Breyer, backed by Justices David H. Souter, Ruth Bader Ginsburg, John Paul Stevens and O'Connor, noted more than 98 percent of IRA investors do not make withdrawals until age 60.

"It's called an Individual RETIREMENT Acc-ount," Breyer said. "It's based on retirement, which is clearly on account of age."

The stakes in the case are high. Last year, more than 1.6 million people filed for personal bankruptcy, compared with 875,000 a decade earlier. Experts say much of that is being driven by people 55 and older who lose their jobs and cannot pay off debts.

"Older Americans who lose their IRAs in bankruptcy will have a sharply reduced ability to support themselves in their retirement years," AARP wrote in its friend-of-the-court filing seeking IRA protection. "Rebuilding retirement savings is a daunting task for anyone, and it is particularly difficult for older Americans."

The case involves Richard and Betty Jo Rousey of Berryville, Ark., who accumulated $55,000 in company-sponsored pension and 401(k) plans at Northrop Grumman Corp. before he took early retirement in 1998. When Betty Jo Rousey was laid off a month later, they rolled the funds over to IRAs.

The Rouseys have been unable to hold down new jobs, in part due to his chronic back pain, according to their attorneys. Richard, 60, and Betty Jo, 57, now live on $2,000 a month.

The couple filed for bankruptcy in 2001 and claimed an exemption for their IRAs. Lower courts disagreed, ruling the couple's ability to withdraw funds at any time made the IRAs more like a "readily accessible savings account" that isn't subject to protection.

Several justices pressed Colli C. McKiever, who represents the trustee overseeing the couple's bankruptcy, on why IRAs should be treated differently from pensions and 401(k)s. They noted the couple had no choice but to roll funds into IRAs after Betty Jo Rousey was laid off.

When McKiever responded that no other retirement plan covered in the statute allows withdrawal "at any time, for any reason," O'Connor disagreed.

"Typically, plans like 401(k) plans allow hardship withdrawals. Others allow for medical reasons," she said. "So it seems like a hard line to draw. We would have endless cases to litigate."

O'Connor then suggested a solution that would give protection to IRAs in the Rouseys' case and others, but only to the extent the money is "reasonably necessary for the support of the debtor and any dependent." That provision is stated separately in the bankruptcy code.

Pamela Karlan, a Stanford law professor who represented the Rouseys, embraced O'Connor's proposal. She argued that IRAs should not be viewed as savings accounts because the tax penalty deters most investors from early withdrawals.

"Congress put in a tax penalty because in the holistic sense, it is designed to protect retirement savings," Karlan said. "If the Rouseys have an old age to live in that is in any reasonable kind of circumstance at all, they'll need this money."

The case is Rousey v. Jacoway, 03-1407. A ruling is expected by July.


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