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The plain Dealer

Not all Pay Attention to Arbitration Clauses

4/26/2005

Armond D. Budish, Esq.

A recent newspaper headline proclaimed “Supreme Court Protects IRAs from Creditors.” Immediately, I received e-mails and calls asking if this case finally settles the questions about whether IRAs are protected against creditors and lawsuits. If only it were that simple! The truth is that the Supreme Court’s decision will probably have little impact on Ohioans’ IRAs, and questions surrounding the protections available will continue.

ERISA Protections

If your retirement savings is in a plan qualified under the federal Employee Retirement Income Security Act (“ERISA”), it generally will be protected from lawsuits and creditors. ERISA covers most retirement funds, including 401(k), ESOP, Keogh, pension and profit-sharing plans.

But ERISA does not insulate Individual Retirement Accounts (“IRAs”) from lawsuits and creditors. So Ohio, like many other states, adopted its own legislation to fill the gap, broadly protecting IRAs.

In 2002, the United States Court of Appeals for the Sixth Circuit (which covers Ohio) threw out a Michigan law which, like Ohio’s, sheltered IRAs from attack. The Court ruled that state laws attempting to protect IRAs are prohibited by ERISA and are, therefore, invalid.

Following that case, several Ohio Bankruptcy Courts have noted that the Sixth Circuit case dealt specifically with a SEP (Simplified Employee Pension) IRA, not a regular or Roth IRA. These courts have decided that the state’s legislative protection for regular and Roth IRAs remains valid.

The Recent Supreme Court Case

The federal Bankruptcy Code allows folks going through bankruptcy to “exempt” or protect certain assets, rather than give them to the creditors. The law clearly states that pension, profit sharing, stock bonus, and annuity plans are exempt. The United States Supreme Court earlier this month ruled that IRAs are also given the same protection.

But there’s a limit to this federal protection. IRAs and other retirement plans are exempt only “to the extent reasonably necessary for the support of the debtor and any dependent of the debtor... ”

The extent of this limitation is not clear, but a number of cases have interpreted this language to severely restrict the protections. To determine whether an IRA is “reasonably necessary” for your support, courts will look at a number of factors, including your:

• Age and health.
• Present and anticipated living expenses.
• Income.
• Ability to work and earn a living.
• Job skills, training and education.
• Other financial resources.
• Ability to save.
• Financial obligations.

If you are old, retired, and sick, with a multitude of medical expenses, it’s more likely a judge will allow you to exempt your IRA. But if you are young and healthy, a judge is more likely to tell you turn your IRA over to your creditors because you’ll have plenty of time to rebuild your retirement savings. Note that one bankruptcy court explained that “The amount exempted should reflect that which is necessary to sustain basic needs, without regard to Debtor’s former lifestyle.”

While this limitation may make it difficult to protect your IRA from creditors, despite the Supreme Court decision, you probably won’t have to worry about it. The Ohio law protecting IRAs provides broad protection and is not limited to amounts “reasonably necessary” for support. And bankruptcy courts in Ohio apply the Ohio law rather than the federal exemption language.

New Federal Bankruptcy Law

At this writing, a new federal bankruptcy law is about to be enacted. The legislation specifically protects IRAs from creditors, but only up to $1 million (though the $1 million cap can be increased “if the interests of justice so require.”) The passage of this law is likely to create new questions concerning the protections for IRAs. For example, will this law take precedence over state laws like Ohio’s (which has no cap)? It appears that it will. And will the $1 million cap apply to amounts rolled over from other pension plans? Roll-overs are probably protected without regard to the $1 million cap, but again the answer’s not clear.

What’s the bottom line? I’m afraid we still have a way to go before the protections for IRAs are fully settled. Hopefully, you won’t have to be one of the test cases.