Justices Debate Keeping IRAs Away From Creditors

With personal bankruptcies rising throughout the nation, the Supreme Court considered Wednesday whether IRAs, the popular retirement savings accounts, were shielded from being seized by creditors during a bankruptcy.

Federal law clearly exempts from seizure pensions, 401(k)s, Social Security benefits and similar plans that give people a “right to receive” payments “on account of illness, disability (or) age.” However, ordinary savings accounts can be seized by a bankrupt person’s creditors.

Not surprisingly, courts around the country are split on whether an IRA, or Individual Retirement Account, should be treated like a pension plan or a savings account.

AARP, the advocacy group for older Americans, says the ruling could have a broad impact, since 1.6 million people filed for bankruptcy last year.

But it would apparently not affect people in California, which is among the states that have shielded IRAs from being seized during a bankruptcy, the court was told.

At least 45 million taxpayers have established IRAs, which enables them to save up to $3,000 a year tax-free. They may withdraw money from these accounts, but will face a 10% tax penalty if they take out the money before age 59 1/2 .

To clarify federal law, the high court took up the case of Richard and Betty Jo Rousey, an out-of-work Arkansas couple who face the loss of their only retirement savings. The two left their jobs with Northrop Grumman Corp. in 1998.

Each had set up a retirement savings account at Northrop, but when they left, they were forced to roll over the money into IRAs. His account had nearly $43,000, and hers had $12,000.

Still unable to find work, the couple were overwhelmed by debts and declared bankruptcy. A court trustee, Jill Jacoway, was appointed to assume control of their assets and to distribute the proceeds among their creditors.

Jacoway maintained that the couple’s IRAs could be seized, and a bankruptcy judge and the U.S. Court of Appeals in St. Louis agreed with her. The judges reasoned that an IRA was like a savings account because money could be withdrawn from it.

Stanford University law professor Pamela Karlan, representing the Rouseys, argued that an IRA was similar to a pension or other retirement plan. She urged the justices to read the Bankruptcy Code as a whole and conclude that the beneficiaries of an IRA would receive money because of their age.

“Congress put in a tax penalty because [IRAs] were designed to protect retirement savings,” she said.

Justices Antonin Scalia and Anthony M. Kennedy, focusing on the wording of the law, said they were not convinced by this argument. A pension check or Social Security benefit is a payment that is received “on account of ... age,” but money from IRAs can be received at any time, regardless of age, Scalia said.

But Justice Stephen G. Breyer, looking at the law as a whole, said it made sense to view IRAs as similar to pensions. “It’s called an Individual Retirement Account,” Breyer said. “It’s based on retirement, which is clearly on account of age.”

By the argument’s end, the justices sounded closely split in the case of Rousey vs. Jacoway.

If the high court rules for the Rouseys, the federal bankruptcy code will shield IRAs nationwide from being seized by creditors. However, if the court rules for the trustee, the status of IRAs will depend on the exemptions set in state law.