High court: IRAs can be shielded from creditors

updated 10:31 a.m. ET April 4, 2005

WASHINGTON - 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.

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.

"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 "Funds in a typical savings account, by contrast, can be withdrawn without age-based penalty."

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."

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