By Sarah Borchersen-Keto, CCH Washington Staff Writer

The U.S. Supreme Court ruled unanimously April 4, 2005, that Individual Retirement Accounts (IRAs) are exempt from an individual's bankruptcy estate under federal bankruptcy law. The Court reversed an earlier decision from the Eighth Circuit Court of Appeals.

The case concerns Richard and Betty Jo Rousey, former employees of Northrop Grumman Corp. At the termination of their employment, they were required to take lump-sum distributions from their employer-sponsored pension plans. The Rouseys deposited the lump sums into two IRAs. Several years after establishing their IRAs, the Rouseys filed a joint Chapter 7 bankruptcy petition in Arkansas, and sought to shield the IRAs from their creditors.

The Bankruptcy Court appointed Jill R. Jacoway as the Chapter 7 trustee. She sought to have the IRA accounts turned over to her, and the Bankruptcy Court granted her motion. The Rouseys appealed, and their case eventually came to the Eighth Circuit Court of Appeals, which upheld earlier decisions in Jacoway's favor. The Eighth Circuit Court ruled that the IRAs were "readily accessible savings accounts of which the debtors may easily avail themselves at any time for any purpose."

In writing the court's opinion, Justice Clarence Thomas stated that the bankruptcy code "permits debtors to exempt certain property from the bankruptcy estate, allowing them to retain those assets rather than divide them among their creditors." Thomas noted that the question in this particular case was whether debtors can exempt assets in their IRAs from the bankruptcy estate, adding, "we hold that IRAs can be so exempted."

The court held that while the Internal Revenue Code permits penalty-free early withdrawals from IRA accounts in limited circumstances, "these exceptions do not reduce the IRAs to savings accounts." Thomas wrote that IRAs fulfilled both requirements under the law for an exemption. They confer a right to receive payments based on age and are similar to other plans or contracts cited in the law which are exempted.

For more information on the current rules of bankruptcy and how they interact with a comprehensive asset protection plan for your small business, check out our book, Safe Harbors: An Asset Protection Guide for Small Business Owners, available at major book sellers. New, stricter rules for debtors will be part of any bankruptcy reform, and you may want to consider what it could mean to you and your business before it's too late.

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