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April 5, 2005
High Court Rules IRAs Untouchable
Unanimous Decision Means Retirement Savings Are Protected From
Creditors
By CHRISTOPHER CONKEY and RACHEL EMMA SILVERMAN
Staff Reporters of THE WALL STREET JOURNAL
In a decision with broad implications for investors worried about
protecting their nest eggs, the Supreme Court ruled that creditors may
not seize individual retirement accounts in bankruptcy proceedings.
Yesterday's unanimous decision adds IRAs to a list of protected
retirement assets that includes Social Security benefits, 401(k)s and
pensions. The ruling reversed a lower-court decision that IRAs
shouldn't enjoy bankruptcy protection because individuals can make
withdrawals before retiring.
The ruling offers a new layer of federal protection for IRA assets,
which could make transfers and contributions to IRAs more attractive.
That could be good news for many people with creditor concerns -- such
as doctors, business executives and other professionals -- who feared
moving their assets into IRAs after changing jobs or opening their own
business.
The Supreme Court decision comes as Congress is expected to pass a bill
this week that would limit the ability of many people to file for
bankruptcy protection. President Bush has signaled he will sign it into
law.
Last year, more than 1.6 million people filed for bankruptcy, a figure
nearly double that of a decade earlier. With the pending legislation
making it harder for middle-income Americans to wipe out their debts in
bankruptcy, consumer groups hailed the decision as welcome relief.
"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 senior attorney for AARP.
More workers are contributing to IRAs and rolling over other assets
like pensions and 401(k)s into IRAs when they change jobs or retire.
Nearly $3 trillion was invested in IRAs at the end of 2003, and the
nonpartisan Employee Benefit Research Institute estimates that number
rose by more 12% last year.
Thanks to the ruling, "we are probably going to see a wave of IRA
rollovers," predicts Ed Slott, a Rockville Centre, N.Y., IRA
consultant. "The Supreme Court produced a huge win for everyone with
IRAs."
The ruling came out right before the April 15 tax deadline. Individuals
have until that date to make contributions to their IRAs for the 2004
tax year. This is the time when many people contribute to their IRAs.
"The ruling gives them an added incentive," Mr. Slott says.
In rejecting the lower-court ruling, the Supreme Court emphasized that
unlike savings accounts, early withdrawals from IRAs trigger 10% tax
penalties. "That penalty erects a substantial barrier to early
withdrawal," Justice Clarence Thomas wrote in the court's opinion.
"Funds in a typical savings account, by contrast, can be withdrawn
without age-based penalty."
The Supreme Court didn't address whether large IRA accounts will be
fully shielded, though. The bankruptcy code says that certain assets
"reasonably necessary" to support the debtor and any dependents may be
protected from creditors. That language means some of the assets in
very large IRAs might not be protected from creditors.
However, the bankruptcy bill expected to pass Congress this week would
cap the IRA exemption at $1 million, excluding rollover deposits that
often make up the bulk of such accounts. This provision would
effectively extend protection to most IRA accounts.
Until yesterday's ruling, IRAs generally weren't protected from
creditors under federal law -- unlike 401(k)s and other
employer-sponsored retirement plans. Instead, IRA protection was
covered by state laws, which vary. Some states like New York and
Florida offer broad protection for IRAs. But other states have
more-limited coverage -- exempting, for instance, only what is
reasonably necessary to support IRA owners and their dependents, or
limiting the exemption to a specific dollar amount.
James Lange, a Pittsburgh lawyer and estate planner, has several
physician clients who have 401(k)s from their prior employers. When
they left their jobs, they opted not to roll over their plans into IRAs
because they worried that creditors could pierce the IRAs. Better
creditor protection made the 401(k) plans more attractive to these
doctors -- even though IRAs generally offer broader and more-flexible
investment and estate-planning options than 401(k)s.
For tax year 2004, individuals can contribute as much as $3,000 of
their annual earnings to an IRA -- or $3,500 for those ages 50 and
older. The contribution limits for 2005 are $4,000 and $4,500,
respectively.
Yesterday's ruling stemmed from a dispute between an Arkansan couple
and the trustee selected to oversee their bankruptcy proceeding.
Richard and Betty Jo Rousey, both former employees of defense
contractor Northrop Grumman Corp., rolled over $55,000 in
company-sponsored pension and 401(k) plans into an IRA after he took
early retirement and she was fired in 1998. Lawyers for the couple say
they filed for Chapter 7 bankruptcy protection, which liquidates
unprotected assets to pay off creditors, after chronic back pain
prevented Mr. Rousey from finding another job.
The court-appointed trustee, Jill Jacoway, objected to their attempt to
exempt their IRA from creditors because, unlike other retiree funds
tied to age, the Rousey's had "unlimited access" to the funds before
retirement. Lower courts agreed with Ms. Jacoway until the Supreme
Court overturned the decision yesterday.
PROTECTING AN IRA
The Supreme Court unanimously voted to extend federal protection to
IRAs:
=B7 Until now, only employee-sponsored retirement plans were shielded
from creditors under federal law.
=B7 IRAs enjoyed protection under many states, but those laws varied.
Because of that, many professionals were reluctant to roll over assets
into these accounts from employer-sponsored plans.
=B7 The court didn't address whether large IRAs would be fully
protected.
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