High Court Holds IRAs Exempt from Bankruptcy Creditors

A unanimous Supreme Court, reversing a decision of the Bankruptcy Court, the Bankruptcy Appellate Panel, and the 8th Circuit Court of Appeals, and in so doing resolving a conflict among the circuits, ruled that debtors in bankruptcy may properly exclude assets in their IRA account pursuant to § 522(d)(10)(E) of the Bankruptcy Code.

[The debtors, former employees of Northrup Grumman, at the termination of employment, were required to take lump-sum distributions from their employer-sponsored pension plans. Pursuant to IRC § 408(d), the distributions were rolled over into separate IRAs. Several years later, the debtors filed a joint Chapter 7 bankruptcy petition, and sought to shield portions of their IRAs from creditors by claiming them as exempt from the bankruptcy estate pursuant to § 522(d)(10)(E).]

Justice Thomas, writing for the Court, agreed with the debtors’ contention that the requirements for exemption had been satisfied: First, the right to receive payment was from “a stock bonus, pension, profitsharing, annuity, or similar plan or contract;” and second, that right was “on account of illness, disability, death, age, or length of service.”

The Court dismissed the argument of the trustee in bankruptcy that the debtors’ right to receive payment was not “on account of illness, disability, death, age, or length of service,” since the debtors could withdraw funds from their IRA at any time. Noting a “causal[] connection to their age,” the Court found that the 10 percent early withdrawal penalty effectively limited the petitioners’ right to “payment” of their IRAs.  Further, because the condition was “removed” upon the petitioners’ attaining the age of 59½, the right to receive IRA payments was indeed “on account of age.”

Next, the Court found that the  “similar plan or contracts” requirement was also met, since the IRA, like profitsharing, pension or annuity plans, bore the “common feature” of providing income which was a substitute for wages. The minimum distribution requirements, which commence when the account holder turns 70½, as well as the likelihood, due to the early withdrawal penalty, that money would be held in accounts until retirement, convinced the Court that the IRA was an income substitute rather than a mere “savings account,” as had been urged by the Trustee.

Similarly, the Court found unpersuasive the Trustees’ contention that the availability of penalty-free distributions in limited circumstances rendered the IRAs as mere savings accounts, remarking that the exceptions were “limited in amount an scope [and] [e]ven with these carveouts, an early withdrawal without penalty remains the exception, rather than the rule.”

Finally, the Court noted that certain clauses expressly exclude from the exemption from the bankruptcy estate certain “rights to payment” that would otherwise benefit from the general exemption. It would make “little sense” to specifically cite elaborate upon certain plans that did not enjoy the exemption, unless other plans, such as IRAs, were generally within the exemption.

This entry was posted in News, Pension & Retirement Accounts, Tax Decisions. Bookmark the permalink.

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