IRAs Shielded in Bankruptcy, Justices Rule

The Supreme Court ruled Monday that people who file for bankruptcy protection can keep the money saved in their individual retirement accounts.

The unanimous decision throws a financial lifeline to the growing number of older Americans who are overwhelmed by debt after losing a job or getting hit by extraordinary costs for healthcare.

Last year, more than 1.6 million people filed for personal bankruptcy -- nearly double the number a decade ago. Legal experts say an increasing number of these heavily indebted people are at the end of their working lives and have no assets or income other than a monthly Social Security check.

When people file for bankruptcy, their creditors are entitled to seize their assets to collect on their debts. This includes money held in a savings account.

But certain assets, such as the debtor’s house and car, typically are shielded from seizure under bankruptcy laws. The federal statute also shields the person’s pension and similar plans that provide money “on account of age.” For the high court, the question was whether an IRA is more like a pension or like a savings account.

The justices decided an IRA is more akin to a pension because account holders can withdraw the money penalty-free only if they are at least 59 1/2 years old. Moreover, an IRA, like a pension, “provides income that substitutes for wage,” Justice Clarence Thomas said.

The ruling will preserve $55,000 in retirement savings for a couple who moved from California to Arkansas after they were forced to retire early from their jobs at Northrop Grumman Corp. with modest pensions. During their working years, Richard and Betty Jo Rousey had saved money through the company’s 401(k) plan. They were in their late 50s when they left their jobs and were obliged to roll the money over into an IRA to avoid a tax penalty.

After moving to Arkansas, Richard Rousey had back trouble and was unable to find a suitable job; the couple were soon overwhelmed by debt, their lawyer said.

Once the Rouseys filed for bankruptcy, Jill Jacoway, the trustee for their creditors, moved to seize the money in their IRAs. A bankruptcy judge and the U.S. Court of Appeals in St. Louis agreed that the money had to go their creditors.

Last year, a group of Stanford University law students appealed to the Supreme Court on behalf of the Rouseys.

In Rousey vs. Jacoway, the justices said Congress intended to shield IRAs from seizure during bankruptcy.

“Today’s decision is important because it provides assurance that a family’s financial bumps in the road will not keep them from having modest additional means -- beyond Social Security -- to help them cope with the many financial pressures of aging,” said Patricia Kaeding , a lawyer in Madison, Wis., who filed a friend-of-the-court brief on behalf of retiree advocacy group AARP and in support of the Rouseys.

Monday’s ruling also is consistent with the terms of a bankruptcy overhaul bill in Congress that is poised for final approval.

The legislation has drawn attention because it will make it harder for bankruptcy filers with above-average incomes to escape their debts. But one provision in the bill shields from seizure “retirement funds ... that are in a fund or account that is exempt from taxation,” such as an IRA.

More than 45 million Americans have established IRAs, which allow them to save money for retirement tax-free.

Several states, including California and New York, generally protect IRAs from being seized in a bankruptcy.

The current federal law says debtors may shield their pensions and retirement funds from creditors only to the extent that the money is “reasonably necessary for the support of the debtor” and dependents.

But the bankruptcy legislation drops that provision and says simply that retirement funds are shielded from being seized when a debtor files for bankruptcy. It has already passed the Senate, and the House is expected to give it final approval this week.