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Creditors May Not Sieze IRAs
Old 04-04-2005, 07:31 AM   #1
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Creditors May Not Sieze IRAs

Just came out on CNBC: Supreme Court rules that creditors may not sieze IRA's. Does that protect IRAs from lawsuits as well?
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Re: Creditors May Not Sieze IRAs--sorta, maybe
Old 04-04-2005, 07:51 AM   #2
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Re: Creditors May Not Sieze IRAs--sorta, maybe

I haven't read the Rousey decision yet and will report after I do, but I do know that the opinion is written by Clarence Thomas so it likely is narrowly crafted.

The case was about the bankruptcy code which provides an exemption from creditors for :

"A payment under a stock bonus, pension, profitsharing, 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. . ."


The Rousey case was about whether an IRA meets this definition. Without actually reading the opinion, I doubt that it would apply in any circumstances outside of bankrupty. But I will report after reading the decision. A lot of our clients' money is riding on it.

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Re: Creditors May Not Sieze IRAs
Old 04-04-2005, 08:37 AM   #3
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Re: Creditors May Not Sieze IRAs

From NYT

WASHINGTON (AP) -- The Supreme Court on Monday ruled that creditors may not seize Individual Retirement Accounts when people file for bankruptcy, giving protection to a nest egg relied upon by millions of Americans.

The unanimous decision sides with a bankrupt Arkansas couple fighting to keep more than $55,000 in retirement savings. As a result, IRAs now join pensions, 401(k)s, Social Security and other benefits tied to age, illness or disability that are afforded protection under bankruptcy law.

IRAs should not be treated any differently because the benefits are tied to people's age, the court said, citing a substantial tax penalty that is imposed for withdrawals before a person turns 60.

``That penalty erects a substantial barrier to early withdrawal,'' Justice Clarence Thomas wrote for the court. ``Funds in a typical savings account, by contrast, can be withdrawn without age-based penalty.''

IRAs allow most investors to contribute up to $4,000 in earned income annually to a fund that grows tax-free until withdrawals. It is the only retirement plan available to the self-employed and small business owners and is typically used by workers between jobs, according to AARP.

But unlike many other retirement plans, IRAs permit cash withdrawals for any reason at any time so long as holders 59 1/2 and younger pay a 10 percent penalty tax. Some lower courts had ruled that makes IRAs different, because people could make withdrawals at any time, regardless of age.

In the ruling, however, Thomas noted IRA withdrawals by those younger than age 60 are few, effectively making the account a benefit based on age.

Last year, more than 1.6 million people filed for personal bankruptcy, compared with 875,000 a decade earlier. Experts say much of that is being driven by people 55 and older who lose their jobs and cannot pay off debts.

The case involves Richard and Betty Jo Rousey of Berryville, Ark., who accumulated $55,000 in company-sponsored pension and 401(k) plans at Northrop Grumman Corp. before he took early retirement in 1998. When Betty Jo Rousey was laid off a month later, they rolled the funds over to IRAs.

The Rouseys have been unable to hold down new jobs, in part due to his chronic back pain, according to their lawyers. Richard, 60, and Betty Jo, 57, now live on $2,000 a month.

Under bankruptcy law, the retirement savings won't be given blanket protection. A separate provision in the law shields the assets only to the extent the money is ``reasonably necessary for the support of the debtor and any dependent.''

The case is Rousey v. Jacoway, 03-1407.

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Re: Creditors May Not Sieze IRAs
Old 04-04-2005, 08:48 AM   #4
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Re: Creditors May Not Sieze IRAs

Boy, this is a big deal that's going to beat the crap out of the 401(k) salesforce industry. I bet millions of people have been sticking with high expenses & poor choices just because they couldn't get creditor protection from an IRA.
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Re: Creditors May Not Sieze IRAs
Old 04-04-2005, 09:01 AM   #5
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Re: Creditors May Not Sieze IRAs

Not really Nords, it likely pertains only to bankruptcy and don't forget, the exemption is only for the amount reasonably necessary for support.

For years bankruptcy courts assumed the exemption included IRAs. It was only recently that some bankruptcy courts decided that an IRA did not meet the requirements of the bankrutpcy code.

As far as what is "reasonable necessary for support", this will be determined by a bankruptcy judge. My experience is that if you are employable and less than maybe 55 years old, very little is going to be found necessary for support. Many bankruptcy courts have not been very generous in the amount they find exempt.

I don't plan on rolling my 401(k) into an IRA.
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Re: Creditors May Not Sieze IRAs
Old 04-04-2005, 11:17 AM   #6
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Re: Creditors May Not Sieze IRAs

I couldnt' imagine this applying to that many people. *

How many individuals are savy enough to save a large net egg for retirement in an IRA, yet poor enough with their financial management to bring themselves to bankruptcy (no emergency fund, excessive borrowing, etc). *Seems like an oxymoron.
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Re: Creditors May Not Sieze IRAs
Old 04-04-2005, 11:45 AM   #7
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Re: Creditors May Not Sieze IRAs

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I couldnt' imagine this applying to that many people.

How many individuals are savy enough to save a large net egg for retirement in an IRA, yet poor enough with their financial management to bring themselves to bankruptcy (no emergency fund, excessive borrowing, etc). Seems like an oxymoron.

Let's see, I'll give you some real life examples:

1. Dad guaranteed son's business debt incurred to buy the business. Son's business failed. Dad now in bankruptcy trying to protect his IRA.

2. Dad and mom saved for years, had plenty in an IRA. Dad died. Mom got depressed and started going to the casino. Eventually ended up in a pile of debt. Now trying to save what is left of their IRAs.

3 .Husband and wife owned a small business. After years of being moderately successful, things went bad and the business went out of business. There was unfunded pension liability to employees. Husband and wife ended up having to file bankruptcy as a result--no other debt. The business was in a corporation. Trying now to save their IRAs.

4. Attorney got cancer and couldn't work anymore. Deciding now whether to file bankruptcy or wait because more bills are on the way. One issue is protecting his and his wife's IRAs.

Martha
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Re: Creditors May Not Sieze IRAs
Old 04-04-2005, 01:26 PM   #8
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Re: Creditors May Not Sieze IRAs

Got another real one for ya...

Family with a bunch of kids LBYM's for about 25 years, putting together a nice retirement savings in an IRA. Father suddenly and unexpectedly dies. Large insurance payout to the family, who suddenly turns into a bunch of drunken sailors with the money. Mother completely remodells the house, kids are buying new cars, youngest without a drivers license buys a riding lawn mower for their 10x15 patch of grass so he can ride it to the store 4 blocks up the street (which I dont even think is legal). Within a year not only the entire insurance payout is spent, but everything in the bank and the credit cards they grabbed up en masse are maxed out.
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Re: Creditors May Not Sieze IRAs
Old 04-04-2005, 02:11 PM   #9
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Re: Creditors May Not Sieze IRAs

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Got another real one for ya...
As the saying goes, you can lead a camel to water but you can't make him LBHM.
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 06:30 AM   #10
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Re: Creditors May Not Sieze IRAs

Well I read the Rousey v. Jacoway case. No surprises. Under the bankruptcy code the right to receive payments from an IRA (and other similar non-ERISA retirement plans) are exempted if they meet three requirements:

1. the right to receive payment must be from a stock bonus, pension, profitsharing, annuity, or similar plan or contract;

2. the right to receive payment must be on account of illness, disability, death, age or length of service; and

3. even then, the right to receive payment may be exempted only to the extent that it is reasonably necessary to support the debtor or the debtor's dependents.

The dispute in the Rousey case was whether IRAs fulfill the first and second requirements. The lower courts and the trustee said no. The rationale was that an IRA is really like a savings account where the saver has unfettered access. It doesn't matter how old the debtor is, the debtor can always take the money out.

The Supreme Court disagreed, saying that the right to payment is in fact causally connected to age because Congress put in place a 10% penalty to discourage early withdrawals. The court also held that IRAs are similar to plans such as pension, profitsharing or annuity plans because all these plans enable Americans to save for retirement.

Duh.

Anyway, a good decision.

The decision only applies to bankruptcy cases and only where the debtor has claimed the federal bankruptcy exemptions. If a person doesn't file bankruptcy whether that person's IRA is protected from creditors is dependent on state law. Some states have specific exemptions for IRAs. However, some states have statutes that are similar to the federal bankruptcy statute. In these states, this decision will be helpful in arguing that IRAs should be exempt.

Don't forget that only the amount "reasonably necessary for support" is exempt under the bankruptcy code and many state statutes.

Martha
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 07:12 AM   #11
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Re: Creditors May Not Sieze IRAs

I'm not sure how I feel about it. Generally speaking, I not sympathetic to folks that are in debt to someone else, and then refuse to pay them with funds that they have (which would include monies in IRAs).

It was instilled in me at an early age if you borrow someone's money, you do everything you possibly can to pay them back.
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 08:00 AM   #12
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Re: Creditors May Not Sieze IRAs

Azanon, in my mind there is plenty of unfairness in bankruptcy, but I see it in different places than you do.

For example, if you live in florida, have $3 million in a 401(k) and own a $2 million dollar home, you won't lose either to creditors. But the Rouseys, who were in their late 50s, had layoffs and health problems which made it tough to get and keep work, had to take it all the way the the Supreme Court to protect $55,000 in IRAs. Law students represented them for free after they first lost their case.

Doesn't sound very fair to me.

The new bankruptcy bill doesn't help this situation a whole lot. It makes it more difficult for the poor to get things together enough to file bankruptcy, but the rich still can protect the big homestead in states like Florida and Texas and the big 401(k)s.

In some ways it might have been good for the court to find IRAs were not exempt. Congress might then have amended the bankrutpcy code to provide for even broader protection for IRAs then currently exists. Frankly I see no reason to treat 401(k)s, pensions and IRAs differently.

Azanon, I tend to tell the sad bankruptcy stories, like the person who gets cancer, loses his job, his house and then needs to file bankruptcy. This and similar situations happen way too often. However, I acknowledge that there are those who have no sense whatsoever, buy whatever they want on credit cards, purchase lots of stuff and give lots of it away to relatives, and finally end up filing bankruptcy, saying "its not my fault". I have even seen a few serial bankruptcy filers sitting in bankruptcy court with smirks on their faces. However, my experience is that they rarely are left with a pot to p**s in and rarely had the foresight to fund an IRA.

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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 08:14 AM   #13
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Re: Creditors May Not Sieze IRAs

Martha-

Can you clarify for me how the protection afforded a 401K is superior to an IRA?

rapoole
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 09:34 AM   #14
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Re: Creditors May Not Sieze IRAs

A relatively quick answer since I am working today. :-/

Under ERISA, tax qualified retirement plans are exempt from creditors, except for some minor exceptions, including qualified domestic relations orders and claims of the IRS for taxes. IRAs are not tax qualified plans under ERISA. This means that they are only exempt from claims of creditors only if some other law provides an exemption. Your state might protect IRAs or if you file bankruptcy and pick the federal bankruptcy exemptions, under the Rousey case the IRA will be exempt to the extent necessary for support. Some states provide complete IRA protection. Some say they are exempt to the extent reasonably necessary for support. Some states provide no protection at all.

In contrast, nearly all 401(k)s have complete protection from creditors under ERISA, no matter how much money is in the plan. ( There may be some oddball 401(k)s that are not covered by ERISA. Also, there is some dispute concerning solo 401(k)s. Some people are now saying that there is no protection under ERISA because there are no employees and others are saying yes there is an employee--yourself.)

BTW, some courts have held that 403(b) plans are not protected under ERISA or only partially protected.

An ERISA pension or an employer established 401(k)under ERISA are the "best" plans to have from a creditor protection standpoint.
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 10:24 AM   #15
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Re: Creditors May Not Sieze IRAs

Martha, you rock! Dory should give you an award for all you add here. Maybe make you a cyber-dame (knighthood?)!
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 10:53 AM   #16
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Re: Creditors May Not Sieze IRAs

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I tend to tell the sad bankruptcy stories, like the person who gets cancer, loses his job, his house and then needs to file bankruptcy. This and similar *situations happen way too often.
According to the "Two-Income Trap" the sad stories happen far more frequently than the frivolous spenders. *Out of 2000+ bankruptcies studied in 2001, 87% were job loss, medical problem, or divorce/separation.

One economist estimated that 17% of all U.S. households could significantly improve their finances with a bankruptcy petition. *Yet out of those ~18 million candidates, only about 1.5M actually file. *And people are getting in a lot deeper before they file-- 20 years ago the non-mortgage debt was 80% of annual income but in 2001 it was 150%.

The frivolous spenders can usually avoid bankruptcy by cutting down on their discretionary spending. *The banking industry estimates that those "frivolites" filing for bankruptcy only make up about 10% of the 1.5M.
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 12:39 PM   #17
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Re: Creditors May Not Sieze IRAs

Martha-

Thank you for that elegant answer to my question.

rapoole
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 01:47 PM   #18
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Re: Creditors May Not Sieze IRAs

Laurence, Rapoole, you're welcome. It's always nice to be wanted.
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 02:55 PM   #19
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Re: Creditors May Not Sieze IRAs
Old 04-05-2005, 03:08 PM   #20
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Re: Creditors May Not Sieze IRAs

Martha-

Do you think that the reasoning in Rousey v. Jacobs extends to Roth IRA's? I would think that it might not since Roths can be withdrawn penalty free after 5 years. The decision appears to put a lot of weight on the 10% penalty.

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