The Supreme Court unanimously agreed on Monday that individual retirement accounts, like pensions, should be shielded from bankruptcy creditors. The ruling in Rousey v. Jacoway settles an issue that had divided lower courts and could have exposed billions of dollars in IRAs to being used to pay off debts.

"As a matter of retirement policy, it is hard to see how the Court could have decided this issue differently," said pension and bankruptcy professional Carol Connor Flowe, a partner at Arent Fox in Washington, D.C. "So much IRA money is rolled over from qualified pension plans."

That was the case for Richard and Betty Jo Rousey of Arkansas, who took their lump-sum pension distributions from the Northrop Grumman Corp. and deposited them into two IRAs. Years later, when they filed a Chapter 7 bankruptcy petition, they sought to protect their IRAs from creditors.

They invoked the section of the bankruptcy law that allows debtors to protect their "right to receive" payments such as pensions and annuities that are made "on account of" age or length of service. IRAs qualified, they said, because they cannot withdraw IRA money before age 59-1/2 without a 10 percent tax penalty.

The bankruptcy trustee, Jill Jacoway, objected, saying that the money could be seized by creditors and arguing that the Rouseys had unlimited access to their IRA money, subject only to the penalty. The Bankruptcy Appellate Panel and the U.S. Court of Appeals for the 8th Circuit agreed with Jacoway that access to IRA money was not dependent on age. The 8th Circuit noted that 2nd, 5th, 6th, and 9th circuits had ruled the opposite way.

Justice Clarence Thomas, writing for a unanimous Court, said that the 8th Circuit was wrong. "The statutes governing IRAs persuade us that the Rouseys' right to payment from IRAs is causally connected to their age." Thomas wrote that the penalty for early withdrawal of IRA money is substantial and therefore limits the Rouseys' right to payments as specified by the law.

"It is not unusual in these economic times for people to change jobsvoluntarily or otherwiseseveral times over the course of their careers. By protecting IRAs from creditors in bankruptcy, this decision allows workers to preserve retirement savings when, after a job change, their circumstances force them into bankruptcy," said Jean Constantine-Davis, a lawyer for the AARP, which sided with the Rouseys in the case.

"Had the decision gone the other way, many thousands of people in circumstances similar to the Rouseys' would have lost retirement savings simply because they switched jobs." Also on Monday, the Court granted review in another bankruptcy case, Central Virginia Community College v. Katz.

The case asks whether Congress, through bankruptcy law, can abrogate state sovereignty in bankruptcy proceedings. In the case granted review by the Court, four Virginia colleges are challenging the right of the supervisor of the bankrupt estate of a bookstore to deny their claims against the bookstore. The case will be argued next fall.

By Tony Mauro
Legal Times
April 4, 2005
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