April 13, 2005
U.S. Supreme Court Holds That Individual Retirement Accounts
May be Shielded From Creditors
Posted with permission of the Wisconsin Law Journal.
In a unanimous decision authored by Justice Clarence Thomas and issued on April 4, 2005, the United
States Supreme Court held that individual retirement accounts ("IRAs") are among a debtor’s exempt
assets shielded from creditors under the U.S. Bankruptcy Code (Title 11). Rousey v. Jacoway, 125 S. Ct.
1561 (2005). In doing so, the Supreme Court resolved a split on that issue among the circuit courts of
appeal, re-emphasizing in the process the importance of a "fresh start" for consumer debtors.
Timothy F. Nixon
(920) 436-7693
(608) 284-2614
(414) 287-9352
tnixon@gklaw.com
The following is based on a summary of
legal principles. It is not to be construed
as legal advice. Individuals should
consult with legal counsel before taking
any action based on these principles to
ensure their applicability in a given
situation.
©2009 Godfrey & Kahn, S.C.
Given the importance IRAs have in financial planning for the American family, the ruling will have broad
implications nationally. Wisconsin exemption law, which debtors can choose to utilize under the Bankruptcy
Code, already protects IRAs, so the case will have less direct significance here. It almost certainly will lead,
however, to a more careful analysis when debtors and their attorneys choose the exemptions (state or
federal) available to the debtor. The decision also reflects the U.S. Supreme Court’s continued willingness to
interpret the Bankruptcy Code’s language "strictly" to protect consumers.
The Bankruptcy Code is designed to provide the honest, but unfortunate, debtor with a fresh start. Local
Loan Co. v. Hunt, 292 U.S. 234, 244 (1934) (citing Williams v. U.S. Fidelity & Guaranty Co., 236 U.S. 549,
554 (1915)). For more than a century, the United States has generally embraced the proposition that
people (and businesses) who fail financially should have the opportunity to start again. That "fresh start"
includes protection from creditors for life’s necessities, so that debtors do not become destitute and/or
require public assistance. Exemptions protect some of the debtors’ property from creditors and generally
include items such as clothing, personal property, and tools necessary for a trade. See, e.g., 11 U.S.C. §§
522(d)(3) and (6). In addition, some (or, in several states, all) of the family’s homestead equity is exempt.
See, e.g., 11 U.S.C. § 522(d)(1) and sec. 815.21(2), Wis. Stats. Accordingly, when creditors execute on
judgments and take property in satisfaction of a debt, exempt property is neither turned over to the
creditor nor sold for the benefit of creditors.
The Bankruptcy Code permits debtors who file for bankruptcy to choose federal exemptions or to utilize
their state’s exemptions if their state law allows it. 11 U.S.C. § 522(b). Wisconsin permits debtors this
choice. The Wisconsin exemptions are generally found in section 815.18, Stats. The exemption election is
all or nothing; that is, debtors may not pick and choose or mix and match among the state and federal
exemptions (or as a bankruptcy lawyer would say, the exemptions may not be "stacked"). 11 U.S.C. §
522(b).
Typically, Wisconsin joint debtors with significant homestead equity (i.e., approaching $40,000) and/or
significant amounts in a retirement plan, such as an IRA, will utilize the Wisconsin exemptions. In
Wisconsin, IRAs are explicitly protected from creditors. Sec. 815.18(3)(j), Stats. Debtors with general assets
that do not fall neatly into any of the exemption categories and who do not have significant homestead
equity more likely will choose the federal exemptions. This is due to the so-called federal "wild card"
exemption, 11 U.S.C. § 522(d)(5), that allows the debtors, in the case of a husband and wife, to exempt
any asset up to $20,450 in value. 11 U.S.C. §§ 522(d)(5) and (m).
Complicating the matter, the specific exemptions for IRAs under the Bankruptcy Code and under Wisconsin
law are not identical. Cf. 11 U.S.C. § 522(c)(10)(E) and sec. 815.18(j), Stats. Under the Wisconsin
exemption, IRAs are exempt without additional requirements other than that the IRA is a qualified account.
The federal statutory exemption, however, limits the debtor’s ability to exempt the IRA to an amount that
is "reasonably necessary" to provide for the debtor’s family. 11 U.S.C. § 522(d)(10)(E). This requirement is
significant because a debtor with funds in excess of those "reasonably necessary" may be denied the
exemption to that extent.See, e.g., In re Kochell, 26 B.R. 86 (Bankr. W.D. Wis. 1982), affirmed 31 B.R. 139
Page 1 of 3
April 13, 2005
exemption to that extent.See, e.g., In re Kochell, 26 B.R. 86 (Bankr. W.D. Wis. 1982), affirmed 31 B.R. 139
(W.D. Wis. 1983), 732 F.2d 564 (7th Cir. 1984). (The pending bankruptcy legislation eliminates the
"reasonably necessary" requirement. See § 224, S. 256.)
The Rousey case dealt with the relatively straightforward legal issue of whether, without reaching the issue
of whether the IRA funds are "reasonably necessary," the IRA could be claimed as exempt. The Rousey’s
chose the federal exemptions, claiming approximately $70,000 as exempt. The money had been "rolled
over" into the IRA from a previous employer’s pension plan. The trustee objected on the ground that IRAs
are not included in the Bankruptcy Code’s illustrative list of exempt retirement assets.
The issue is significant for many families. More than 45 million taxpayers have IRAs, and IRA savings have
grown steadily from $85 billion in 1983 to $2.5 trillion at the end of 2001. See Paul J. Graney, Individual
Retirement Accounts: A Fact Sheet, CRS Report for Congress, Code 94-83 EPW (Dec. 5, 2003). Congress
made IRAs universally available in 1981 to encourage individuals to put aside earnings and to permit the
earnings to grow tax-free until withdrawn. Individuals must begin to withdraw money at the age of 70½.
While money may be withdrawn prior to the age of 59½, that withdrawal comes with a 10 percent penalty.
The Rouseys argued that their IRA was primarily a retirement vehicle – a modest addition to the retirement
benefits provided by Social Security. The bankruptcy trustee argued that an IRA is more like a savings
account in that the debtor has access to the cash and that the penalties paid to receive the money before
retirement are relatively modest.
The specific language at issue, in 11 U.S.C. § 522(d)(10)(E), states that a debtor may exempt:
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, to the extent reasonably necessary for the support of the
debtor and any dependent of the debtor.
In writing for the unanimous Court, Justice Thomas carefully analyzed the first two parts of the statute. The
functional issue was whether an IRA is more like a savings account that creditors can generally access or
more like a pension that creditors generally cannot access. The legal analysis starts with determining
whether IRAs are "similar plans or contracts" within the meaning of the statute. According to Justice
Thomas, "to be ‘similar,’ an IRA must be like though not identical to the specific plans or contracts listed" in
the statute. In other words, IRAs must be similar to stock bonuses, pensions, profit sharing plans or annuity
contracts that have the same primary purpose – enabling Americans to save for retirement. According to
Justice Thomas, IRAs "provide a substitute for wages (by wages, for present purposes, we mean
compensation earned as hourly or salary income), and are not mere savings accounts. The Rouseys’ IRAs
are, therefore, similar" to the enumerated examples.
The Court next examined whether the payment was on account of "age." The justices ruled that the
debtors’ ability to withdraw the funds with a 10 percent penalty before age 59½ did not make an IRA more
like a standard savings account than a pension. The Court found "unpersuasive" the trustee’s argument
that this availability makes IRAs like savings accounts and, accordingly, "reject[ed]" it. The justices held, as
a matter of law, that an IRA satisfies the first two parts of the statutory exemption requirements.
It is inaccurate to say that the Court recognized a blanket bankruptcy exemption for IRAs. The court ruled
on the relatively narrow legal issue of whether, in the first instance, IRAs qualify as a Bankruptcy Code
exemption. The question faced by bankruptcy courts in the future should be limited—unless Congress first
changes the law, as it may well do—to the case by case factual determination of whether the IRA funds are
"reasonably necessary" for support. Courts in Wisconsin have, at times, ruled against debtors on this issue
under the facts of a particular case. E.g., Kochell, 26 B.R. 86. Debtors selecting the Wisconsin exemptions,
however, thus far have not had to pass any "reasonably necessary" test. There is none in the text of the
state statute. In re Farmer, 295 B.R. 322, 325 (Bankr. W.D. Wis. 2003).
Page 2 of 3
April 13, 2005
The Rousey decision ratifies the conclusion previously reached by the majority of Wisconsin courts and
bankruptcy lawyers. See, e.g., In re Cilek, 115 B.R. 974 (Bankr. W.D. Wis. 1990). As a result, debtors now
have certainty on the treatment of their IRAs. Debtors with little or no equity in a house, but who do have
both a "wild card" asset and an IRA, however, will need to make strategic choices and engage in careful
planning.
Issues concerning the relative rights of debtors and creditors will, by definition, always be with us since
lending money always entails the risk of not getting it back. However, at least with respect to whether IRAs
qualify as a federal exemption under the Bankruptcy Code – that issue is now settled.
Receive Future Client Updates and Alerts Via E-mail
If you would prefer to receive this type of information by e-mail, please send your name, address, phone
number and e-mail address to marketing@gklaw.com.
877-455-2900
www.gklaw.com
Offices in Milwaukee, Madison, Waukesha, Green Bay & Appleton, WI; Washington, DC
Page 3 of 3