Supreme Court Will Consider Bankruptcy Law Treatment Of IRA Assets

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The U.S. Supreme Court may decide whether rolling 401(k) plan assets into ordinary individual retirement accounts exposes the assets to attacks by creditors in bankruptcy cases.

The court has agreed to consider Rousey vs. Jacoway, a case originally heard in Arkansas.

Richard and Betty Jo Rousey, the husband and wife involved in the case, worked for an aerospace manufacturer. After they stopped working for the manufacturer, they rolled about $55,000 in 401(k) plan assets into 2 IRAs at a local bank in 1999. In 2001, they filed for protection from creditors under Chapter 7 of the U.S. Bankruptcy Code.

Documents from the Rousey’s bank show that the Rouseys could withdraw money from the IRAs at any time but might have to pay the 10% federal tax penalty on early IRA withdrawals.

The defendant in the case, Jill Jacoway, is the Rousey’s bankruptcy trustee. Jacoway has been responsible for determining which of the Rouseys assets can be used to pay creditors. Jacoway has argued that in Arkansas, which is under the jurisdiction of the 8th U.S. Circuit Court of Appeals, the courts have ruled that ordinary IRAs are part of the debtor’s bankruptcy estate.

The courts in the 2nd, 5th, 6th and 9th circuits say that, in most cases, federal bankruptcy excludes IRA assets from the debtor’s bankruptcy estate.

Thomas Goldstein, the Washington lawyer representing the Rouseys, says he thinks financial advisors should pay close attention to the case if the Rouseys lose.

“If we’re wrong, then maybe financial planners ought to be telling clients about not rolling their retirement assets into IRAs, because there’s always the possibility that they might go bankrupt,” Goldstein says.

Colli McKiever, a Fayetteville, Ark., lawyer who is representing Jacoway, says she encounters questions about bankruptcy court treatment of retirement plan assets about 6 times per year. Many of the debtors have 401(k) plan accounts, retirement annuities or other arrangements designed in such a way that the 8th Circuit would continue to let the debtors exempt the assets from their bankruptcy estates, McKiever says.

Determining whether debtors could exempt the assets in an annuity “would depend on the wording of the document that governs the annuity,” McKiever says.

The federal law that covers treatment of retirement plan assets in bankruptcy, Section 522(d)(10)(E) of Title 11 of the U.S. Code, states that “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” is exempt from the debtors bankruptcy estate under many conditions.

Creditors might be able to get into the retirement plan or contract if the arrangement fails to qualify under Section 408 of the Internal Revenue Code, which sets out the rules for IRAs, or one of the other sections of the Internal Revenue Code that describe other types of tax-qualified retirement plans, according to the text of the statute.

Section 522(d)(10)(E) seems to exempt retirement arrangements from the bankruptcy estate only when “the payments made from them must be triggered by illness, disability, death, age, or length of service,’” Circuit Judge David Hansen, a judge with the 8th Circuit Court of Appeals, writes in an opinion released in October 2003.

The payments “are not on account of age” where debtors have unfettered discretion to withdraw from the corpus at any time subject only to modest early withdrawal tax penalties,” Hansen writes.

But “we recognize that 4 of our sister circuits have reached a contrary result,” Hansen writes.

Earlier, U.S. Bankruptcy Judge Robert Kressel wrote in an opinion about an 8th U.S. Circuit Bankruptcy Appellate Panel ruling against the Rouseys that the type of vehicle they used to hold their IRA assets might have affected the vulnerability of the assets to bankruptcy creditors.

“The type of IRA investments that the debtors could have chosen is extremely broad,” Kressel writes in the opinion. “They could have chosen to use it to purchase annuities that limited their access and started payments to them when they reached a certain age. Instead, they chose to put it into a bank account, to which they had unlimited access.”

The author of the opinion in the 1996 5th U.S. Circuit IRA asset case, In re Carmichael, which held that U.S. bankruptcy laws usually do protect IRA assets from creditors, argued that exposing 401(k) plan assets that have been rolled into an IRA to bankruptcy creditors would create a trap for the unwary.


Reproduced from National Underwriter Edition, June 11, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.