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Supreme Court says IRAs are exempt assets in bankruptcy

I've been waiting for this for months. Last fall the Supreme Court heard a case where they were asked to decide if an IRA is exempt from bankruptcy like pensions are. On Monday they published their unanimous opinion: yes, IRAs are like pensions, profit sharing or stock bonus plans, and are therefore exempt under bankruptcy law. The bankruptcy trustee argued that IRAs are more like savings accounts which can be accessed any time. But the Supreme Court decided that the 10% penalty for early withdrawal made them more like exempt retirement plans than non-exempt savings accounts.

My understanding is that even if an IRA is exempt in bankruptcy, it is exempt only to the extent that the debtor needs the funds for his support.

Debtor/creditor law is not my field, but I don't think this opinion means that IRAs are safe from all creditors. If someone breaks a leg on your property and they get a judgment against you (but you're not bankrupt), state law, not bankruptcy law, would still dictate whether they could attach your IRA to pay the judgment. In most states IRAs are exempt from creditors.

The court did not address non-qualified annuities.

Qualified Plans must now roll small cash-outs to IRAs

Qualified plans (pensions, profit sharing plans, 401(k)s, TSAs, rollable 457s) are allowed to automatically cash out a small (under $5,000) account when an employee under age 62 retires, quits, or gets fired. Plans like this rule because they can get these small accounts off their books. In the past, plans have automatically cashed out employees by sending them a check, unless the employee requested that the funds be rolled into an IRA. Most employees, of course, just cashed in the check, losing all the benefit of having qualified money.

Congress wants to encourage retirement savings. It has discovered that by setting the defaults in favor of saving, people will put/keep money in retirement accounts. So now Congress has done that with automatic cash-outs.

The default now is that if an employee terminates with a small account balance, his pension will automatically roll it to an IRA unless the employee asks for a check (the reverse of the past procedure). Plans can still send a check (rather than roll) if the account is less than $1,000. Therefore, if an employee terminates with an account between $1,000 and $5,000, the pension plan cannot automatically cash out but must roll the account into an IRA unless the employee asks for a check.

The plan can go to any IRA vendor to roll over the account. (If a plan approached Integrity, we would want the employee/IRA owner to sign the application. We would not want a contract where the plan participant is missing.)

If the plan rolls an account balance to an IRA without the specific consent of the employee, the plan must put the funds into investments that are designed to preserve principal--like money market accounts, interest-bearing accounts, CDs or stable value products. I would interpret this to mean that a plan could only roll over to a fixed annuity, not a variable. Annuities are specifically allowed as a rollover option.

This material reflects Integrity Life Insurance Company's understanding of the current federal tax laws and contains information of a general nature. The information provided is not intended to be legal or tax advice. Integrity suggests you or your clients consult a tax advisor or attorney as to the applicability of this material or a specific situation.

For more detail on Integrity Life Annuities please contact the Integrity Life Sales desk at 800-900-6460 to obtain a prospectus. Products are issued by Integrity Life Insurance Company, Cincinnati, Ohio. Products sold in New York, Vermont and New Hampshire are issued by National Integrity Life Insurance Company, Goshen, NY. All products distributed by Touchstone Securities, Inc. Cincinnati, OH member NASD/SIPC.

Broker-dealer/agent use only

Margaret A. Kruse
Product Tax Counsel
The Integrity Companies
515 West Market Street
Louisville, KY 40202
888.644.2300 ext. 7945

Last Updated: 5/11/2005 6:00:00 PM