Berryville couple's retirement fund case reaches U.S. Supreme Court

Monday, December 6, 2004

Arguments in the case of a Berryville couple seeking to exempt their 401K retirement accounts from their Chapter 7 bankruptcy proceedings were heard before the U.S. Supreme Court on Wednesday.

A ruling in the case is expected by July.

The case of Richard Gerald and Betty Jo Rousey originated in U.S. Bankruptcy Court in the Harrison Division of Western District of Arkansas.

The Rouseys sought to exclude $55,033.48 in two IRA certificates at First National Bank of Berryville from bankruptcy proceedings.

Chapter 7 trustee Jill Jacoway of California, where the Rouseys formerly resided, objected and moved for turnover of all but 10 percent of the IRA's value, which was sustained by U.S. Bankruptcy Judge Robert F. Fussell, now retired, on Feb. 12.

The 10 percent of the IRAs which was exempted consisted of penalties imposed for early withdrawal prior to age 59 1/2.

In a 20-page brief for the Rouseys, filed with the U.S. Supreme Court, Washington, D.C. attorney Thomas C. Goldstein characterizes Jacoway's position as implausible, saying that she asserts that "IRAs operate more like 'all-purpose investment kitties' than retirement plans," despite the fact that the acronym IRA stands for Individual Retirement Account.

Jacoway "claims that IRAs fail the statutory requirement of being a 'similar plan or contract' to other 'stock bonus, pension, profit sharing, [or] annuity' plans that do qualify for exemption," Goldstein argues.

Goldstein maintains that Jacoway's conclusion rests of false premises that IRAs are not retirement-savings vehicles because holders can, under certain circumstances, gain access to the funds before retirement.

"In fact," he writes in the brief to the Supreme Court, "holders of IRAs have the right to receive payments under precisely the triggering events ... as well as a few other carefully delimited circumstances. Otherwise, if they seek early access to the funds, they are subject to a significant penalty. ... The fact that someone can engage in behavior if he or she is willing to pay a substantial penalty can hardly be described as conferring a 'right' to engage in the conduct."

The Rouseys also reject Jacoway's claim "that IRAs are somehow unique among retirement vehicles" because of the access allowed prior to reaching retirement age

Jacoway's claim that "IRAs fail the statutory requirement of being a 'similar plan or contract'" is mistaken, according to Goldstein's brief.

He notes that stock bonus plans, pensions, profit sharing plans and annuities treat early withdrawals in the same way that IRAs do. Therefore, Jacoway's "argument would lead to the untenable conclusion that many of the plans Congress expressly lists in Section 522(d)(10)(E) would not themselves be exempt.," making the bankruptcy exemption an "empty shell."

In calling for the reversal of Fussell's judgment, Goldstein rejects Jacoway's argument that IRAs are not really retirement vehicles, and differ significantly from general savings accounts.

He notes that in establishing IRAs, Congress concluded that then-present law discriminated against the self-employed and persons not covered by qualified pension plans, and recognized the need for equity on the part of such persons to provide them with a limited tax deduction for their retirement savings.

In a footnote to his brief, Goldstein states that IRAs often constitute the sole retirement vehicle available to the self-employed, and that a growing part of the work force, whose employers do not provide an employer-sponsored retirement plan, find IRAs to be a critical mechanism for retirement savings.

He terms as "linguistic legerdemain" Jacoway's claim that "individuals have a 'right' to withdraw money from an IRA at any time," subject to a "modest" penalty.

In fact, he says, it is "clear that Congress imposes a significant penalty on individuals who remove funds from an IRA without satisfying the triggering events. To say that an individual who is penalized for engaging in a particular conduct has a 'right' to engage in the conduct because he is willing to pay the penalty is absurd."

A working person with an IRA, whose gross income is taxed at a rate of 25 percent must pay a 35-percent federal tax on any amount withdrawn early. That is in addition to the 10 percent penalty of the gross amount in the IRA which cannot be withdrawn early.

Jacoway's argument that IRAs are more like savings accounts is flawed, as traditional savings accounts permit penalty-free withdrawals for any reason at any time, the attorney continues. Further, contributions to IRAs are limited, where deposits in a traditional savings account are not.

Perhaps most interesting is the fact that IRAs can accept "rollover" funds from other retirement vehicles, such as 401(k)s and pensions, which are exempt from seizure in bankruptcy.

In fact, Goldstein said, both the Rouseys' IRAs contain rollover funds from other plans, which were transferred without incurring tax liability.. The ease of transfer, he said, clearly "shows that IRAs serve a function identical to that of plans listed in Section 522(d)(10) (E)."

The Associated Press reported Wednesday that Supreme Court justices strongly questioned Jacoway's attorney, Colli C. McKiever, on why IRAs should be treated differently from pensions and 401(k)s, noting that the Rouseys had no choice but to roll funds into IRAs after Betty Jo Rousey was laid off.

Justice Sandra Day O'Connor suggested that protection could be given to IRAs to the extent that the money is "resonably necessary for the support of the debtor and any dependent," which is permitted in the bankruptcy code, according to the AP.

"Tax-penalized early withdrawal thus cannot form the basis for finding IRAs to be dissimilar from pension plans, stock bonus plans, profit sharing plans and annuities," Goldstein continues. "Nothing in the tax code prohibits accessing funds from any of of these plans at any time, provided that the holder is willing to pay a tax penalty."

Precluding exemption for plans with such a feature would effectively disqualify the very plans and contracts which presently qualify for exemption from bankruptcy seizure, he says.

In Judge Fussell's Feb. 12, 2002, ruling in Harrison, he states that "It seems the number of different judicial interpretations of the 522(d)(10)(E) exemption is limited only to the number of courts that analyze the issue."

At least four circuit courts of appeals have concluded that "some ---- if not all ---- IRAs" were intended to be included among exempted plans, Fussell stated. Each of the four circuits contained the notion of Congress's mention of the Internal Revenue Code compels a holding that Congress intended for IRAs to be included in the exemption.

However, he further noted, that precedent within the U.S. Eighth Circuit Court of Appeals, which includes Arkansas, runs counter to that of the more recent rulings of the other four circuits

With a case from Iowa, where the state has opted out from the federal exemption scheme, the Eighth Circuit determined that IRAs were not "similar plans or contracts."

The Eighth Circuit Bankruptcy Appellate Panel further held that an annuity was not a "similar plan or contract," holding that a tax penalty is not necessarily a limit on withdrawal.

Fussell stated that the Eighth Circuit's analysis is in stark contrast to other holdings. While bound to follow the precedent of the Eighth Circuit, he said he is "convinced that the Eighth Circuit analysis is the better rule of law."

Meanwhile, on Aug. 20, the American Association of Retired Persons weighed in, filing a brief as a friend of the court in support of the Rouseys.

In that brief, AARP attorneys tell the Supreme Court that "a second question in this case arises only if the court rules against the Rouseys on the first question: Whether the exemption for IRAs ... is available only where a debtor is receiving ---- or is eligible to receive ---- payments in accordance with the Internal Revenue Code.

They note that courts in the U.S. Court of Appeals for the Third Circuit allow IRAs the exemption only where the debtor is at least age 59 1/2.

Noting that the importance of exemptions in personal bankruptcy is a concept at least as old as the United States itself, the AARP attorneys state that "some exemptions, like 'professional books' and the 'tools of the [debtor's] trade' are specifically intended to preserve the debtor's ability to earn or receive income in the future. So are the specific exemptions for Social Security, unemployment, disability and other benefits" as contained the bankruptcy law.

"Congress was acutely aware that a bankruptcy law that left a debtor stripped bare, unable to earn a living, would not advance one of the principal goals of the (bankruptcy) Code: to ensure that debtors could quickly become not only technically solvent but self-supporting."

AARP further maintains in the brief that "Congress has clearly expressed its intent to facilitate, to encourage and to protect retirement savings, whether they are in IRAs or another recognized plan. It has done that by providing favorable tax treatment for retirement savings. When the language of the Bankruptcy Code is so clear, especially with its explicit reference to the Internal Revenue Code, no court should be tempted to take away the benefits that Congress has provided, especially for individuals and families trying to support themselves after bankruptcy."

AARP notes that in the past year, more than 1.6 million Americans filed for personal bankruptcy, and Americans age 65 and older are now the fastest growing group in bankruptcy.

The significance of the case, AARP attorneys state, "lies not in the rules of statutory construction but with the desire of Congress to encourage and protect the retirement savings of all Americans. Are IRAs protected by statutes, available, especially in retirement, to facilitate a debtor's self-support and keep the promise of 100 years of bankruptcy law? Or are they indistinguishable from fine jewelry or ordinary bank accounts that can be used to satisfy creditors?"

Respond to this story

Posting a comment requires free registration: