Last month, we looked at the history of Rousey v. Jacoway and began to consider the arguments of the debtors, the trustee and the amicus in light of the Third Circuit's decision in Clark v. O'Neill (In re Clark), 711 F.2d 21 (3d Cir. 1983).¹ The trustee did not press the question suggested by Clark that Bankruptcy Code §522(d)(10)(E) exempts only a "right to payment" and not the underlying source of the payments, such as individual retirement accounts (IRAs). The text of the statute strongly suggests this possibility.² But if this section exempts only a right to payment, then debtors must turn to other exemptions (or exclusions) to protect the corpus of their retirement funds. Because the Court did not address this issue, I interject at occasional points into the oral argument to suggest why the Court should consider this possibility.

Oral Argument³

Justice O'Connor: Aren't most of the pension profit-sharing, stock bonus plans, and annuities similar to the IRAs in terms of allowing withdrawal on the payment of a penalty? So the effect of this rule of the Eighth Circuit is that they would all fail to qualify under the bankruptcy, isn't it?

Prof. Pryor: Not exactly, Justice O'Connor. Part 2 of Title I of ERISA (which prohibits alienation of pension plan benefits) specifically excludes IRAs. ERISA §201(6). Since IRAs enjoy their tax-advantaged status by virtue of IRC §408, the anti-alienation requirements of IRC §401(a)(13) do not apply to them. Thus, nothing in the Internal Revenue Code prohibits voluntary or involuntary withdrawals from IRAs at any time. Pension plans come in two basic types: defined-benefit plans and defined-contribution (also known as individual account) plans. ERISA §§3(34) and (35). Defined-benefit plans are the traditional sort of pension plans, but defined-contribution plans (frequently profit-sharing plans) have become more common, especially since the revision of the IRC in 1986.

Participants may make withdrawals from traditional defined-benefit retirement plans only by terminating employment through retirement, separation from service, disability or other very limited situations. IRC §§411-(a) and (b)(1)-(2). Participants may make withdrawals from defined-contribution plans for the same sorts of reasons, plus, if the plans so provide, hardship (and even then only of their elective contributions). IRC §401(k)(2)(B). Safe harbors for "hardship" distributions are found at Treas. Reg. 1.401(k)-1(d)(3).⁴ Disregard of these limitations could disqualify the plan. IRC §§401(a) and (k)(1).

Loans from defined-benefit plans are not generally allowed. Loans from defined-contribution plans that permit them will be treated as taxable distributions to the participant under IRC §72(p)(1) unless they meet all of the criteria for exception under IRC §72(p)(2).⁵

Justice Breyer: The statute uses the word "payment." So suppose you simply have an IRA plan but you don't take money out of it. Then is it exempt from bankruptcy?

Prof. Pryor: Many state statutes exempt IRAs.⁶ However, if Code §522(d)(10)(E) is construed to exempt only a "right to payment," then nothing under federal bankruptcy law would exempt an underlying IRA from the bankruptcy estate.⁷

Justice Breyer: It sounds as if a person were to withdraw from an IRA before he's 59 and pay the 10 percent income tax penalty under §72(t), then the amount that he took out would not be a payment "on account of" age, but one that he took out after he's 59 and didn't pay what the penalty would be.

Prof. Pryor: The trustee, debtors and amicus focused their attention on the construction of two internal phrases in §522(d)(10)(E): whether IRAs were "similar" to the four enumerated plans and whether withdrawals from IRAs were necessarily "on account of" one of the five permitted purposes. Because their briefs considered these two issues in depth, I prefer to focus my remarks on the unasked question: Are IRAs included within preliminary "right to payment" language?

Justice Stevens: It seems to me the easiest black-letter rule is no penalty tax or some penalty tax. I mean, if withdrawals from IRAs were totally free, like withdrawals from an ordinary bank account, then the trustee would be dead right. But the fact that Congress put in a 10 percent income tax penalty for most withdrawals from IRAs before 59 seems to put it into the category of things that you're not supposed to have an absolute right to get.

Prof. Pryor: The Eighth Circuit held that payments from the IRAs were not "on account of illness, disability, death, age or length of service" because the Rouseys had "unfettered discretion to withdraw from the corpus at any time subject only to modest early withdrawal tax penalties." Rousey v. Jacoway (In re Rousey), 347 F.3d 689, 693 (8th Cir. 2003) (internal quotation marks omitted). As I mentioned above, the parties have sufficiently briefed this issue, so I'll pass on it. I am concerned, however, that the Court consider whether only a right to payment from an IRA, as distinct from an IRA itself, is exempt.

Justice Souter: If, as the trustee asserts, the criterion of exemptibility should be the total freedom of withdrawal for any purpose, then why don't we face the daunting question of predicting the future? Because the question then is going to be, "well, what purposes are sufficiently close to old age to allow for a continued exemption, and how free may the purposes be before a plan falls into the IRA category?" The kind of the paradigm example plans vary enormously depending on the terms in which employers set them up. So if we say that the dividing line is going to be between plans under which withdrawal can be for any purpose versus plans in which withdrawal is going to be somehow limited, then we're going to have to litigate an awful lot of plans, aren't we?

Prof. Pryor: The prospect of such daunting predictions of the future are a good reason to believe that Congress never intended §522(d)(10)(E) to be used to exempt the corpus of retirement savings. What would be necessary for a debtor's future support depends on variables such as the current age and health of the debtor, other sources of retirement income, the age of the debtor at retirement, the prospects of the debtor's future health and the ability of the debtor to make future contributions to retirement accounts. Such a "muddle" would require the testimony of experts according to Delaney v. Obuchowski (In re Delaney), 268 B.R. 57, 62 (D. Vt. 2001).

Justice O'Connor: Isn't it simpler to just recognize that these plans are covered despite the right to withdraw and then rely on the provision in the statute that only permits the deduction to the extent reasonably necessary for the support? I mean, that seems to me a fall-back position that's provided for in the statute.

Prof. Pryor: It's a "fall-back position," but only to the extent that the bankruptcy court is measuring the exemptibility of a right to payment. Congress placed no limit on the exemption of the amount of a debtor's right to payment from a large number of sources such as social security, unemployment compensation, public assistance, veterans' benefits and disability benefits. Code §522(d)(10)(A)-(C). On the other hand, Congress imposed on alimony and support payments (§522(d)(10)(D)) and on wrongful death and life insurance benefits (§522(d)(11)(B) and (C)) the same "extent reasonably necessary for support" standard as it did for the payments exempted under §522(d)(10)(E). Congress's rationale for "necessary for support" cap on certain payments would appear to be the assumption that the unlimited rights to payment are not the sort likely ever to be excessive and thus the bankruptcy court doesn't need to take the time to evaluate them: "Congress simply assumed that the [amount of a public] benefit would be necessary." In re Dale, 252 B.R. 430, 436 (Bankr. W.D. Mich. 2000), aff'd., Dale v. Puerner (In re Dale), 264 B.R. 875 (W.D. Mich. 2001), rev'd. per curiam, 43 Fed. Appx. 911 (6th Cir. 2002).⁸ Other streams of payment, however, could be much more than necessary for the debtor's support and therefore come in for judicial scrutiny.

Justice Breyer: I'm reading the statute. If I were voting on it and saw the reference to IRC §408 in §522(d)(10)(E)(iii) and realized that it refers to an "individual retirement account," I would have thought that they'd be included. Now, is there any indication that when Congress passed this they didn't think IRAs would be? Any reference in the terrible words "legislative history" that might shed light on it?

Prof. Pryor: The House Report notes that the purpose of §522(d)(10) as a whole was to "exempt certain benefits that are akin to future earnings of the debtor." H.R. Rep. No. 95-595, reprinted in 1978 U.S.C.C.A.N. 5963, 6318.⁹ Section 541(a)(6) had broadened the definition of "property of the estate" to include five aspects of future income in the debtor's bankruptcy estate: proceeds, product, offspring, rents and profits. Specifically excluded from the expanded scope of §541(a), however, were "earnings from services performed by an individual" after commencement of the case. While the benefits exempted by §522(d)(10) are not literally "earnings from services," they are substitutes for such earnings for the benefit of those who cannot work due to unemployment, disability or the like. The exempted benefits are rights to payments that, while not excluded from the definition of property of the estate like earnings, nonetheless provide the recipient with the functional equivalent of earnings. The fact that Congress chose to exempt these rights to payment means that otherwise they would have been property of the estate.¹⁰ As Bankruptcy Judge Hughes put it, "Congress intended §522(d)(10) to ensure that deserving debtors who are receiving non-wage benefits...receive the same treatment as debtors who are employed." Dale, 252 B.R. at 436. After all, contributions to pension plans are commonly understood as deferred compensation from the period prior to the bankruptcy that are part of the bankruptcy estate.¹¹ See, e.g., In re Edmonds, 273 B.R. 527 (Bankr. E.D. Mich. 2000) (holding that debtor's contingent interest in year-end profit-sharing payment attributable to pre-petition earnings was property of the estate). Pre-petition earnings are clearly property of the estate, so we can see why Congress's description of these rights to payment as "akin to future earnings" is consistent with treating the stream of payments—but not the underlying corpus—as exempt.

Another important element of the legislative history suggests that Congress did not intend to exempt retirement assets under §522(d)(10)(E). Congress drew much of the exemption language of §522(d) from the Uniform Exemptions Act of 1976. H.R. Rep. No. 95-595, reprinted in 1978 U.S.C. C.A.N. 5963, 6317. Section 6 of the Act provided that:

(a) An individual is entitled to exemption of the following property to the extent reasonably necessary for the support of him and his dependents:

(5) assets held, payments made, and amounts payable under a stock bonus, pension, profit-sharing, annuity, or similar plan or contract, providing benefits by reason of age, illness, disability or length of service (emphasis added).

Congress's change of "property" to the narrower "right to payment," and its omission of the words "assets held," strongly suggest §522(d)(10)(E) should not extend to underlying retirement assets. See, generally, In re Kochell, 732 F.2d 564 (7th Cir. 1984).

More importantly, Your Honor, is understanding why §522(d)(10)(E)(iii) refers to IRAs. This subsection serves only to exclude certain rights to payment that would otherwise be exempt. An account denominated as an "IRA" may not qualify under IRC §408. For example, anyone could open more than one account with a bank or brokerage firm as an IRA, even though he or she had already contributed the maximum deductible amount to another account.¹² Congress intended that not even the stream of payments from such an account should be exempt.

Justice Ginsburg: You don't dispute...that only a small percentage of people who have IRAs in fact exercise the right to withdraw, given the penalty?

Prof. Pryor: I cannot express an opinion on this question. The bankruptcy court in American Honda Fin. Corp. v. Cilek (In re Cilek), 115 B.R. 974, 988 n.15 (Bankr. W.D. Wis. 1990), found that 1.2 percent of IRAs were withdrawn subject to the 10 percent penalty for early withdrawal in 1987 and 1.27 percent in 1988. The court's "finding," however, was based on a telephone call to the national association of credit unions. Such a fact is well outside the scope of judicial notice. FRE 201.

Justice Ginsburg: Does your argument draw a ring around IRAs? It was suggested that if your argument prevails, then these other plans would be affected as well.

Prof. Pryor: That's correct; only a variety of rights to payment are protected by §522(d)(10), not the corpus of retirement funds. Congress has protected certain forms of retirement savings by excluding them from the bankruptcy estate. Code §541(c)(2). See Patterson v. Shumate, 504 U.S. 753 (1992). Justice Blackmun's opinion in Patterson at one point suggests that a debtor's interest in "these plans" (including government and church plans, for which ERISA does not mandate an anti-alienation provision, as well as IRAs, which are not covered by ERISA) "could be exempted under §522(d)(10)(E)." Patterson, 504 U.S. at 763. But he immediately hastened to add that "[w]e express no opinion on the separate question whether §522(d)(10)(E) applies only to distributions from a pension plan that a debtor has an immediate and present right to receive, or to the entire undistributed corpus of a pension trust." Id. at n.5 (emphasis added). The Patterson opinion thus left open the question currently before the Court.¹³

One might question why the Code leads to such disparate results without concluding that Congress could not have intended such an outcome. Beginning long before and continuing for several years after enactment of ERISA in 1974, most pension participants were covered by defined-benefit pension plans. Highly mobile workers were not fond of defined-benefit plans, and since 1987 defined-contribution plans have flourished at the expense of their more traditional cousin.¹⁴ But in 1978, when Congress was drafting the Code, IRAs had existed for only five years, and they certainly had not become the all-purpose repositories for roll-overs from defined-contribution plans. It seems certain that Congress simply did not anticipate that vast amounts of Americans' retirement savings would be held in a form that was not excluded from bankruptcy estates under §541(c)(2). This unfortunate lack of foresight explains why Congress fully protected the then-familiar form of retirement savings and left the now-ubiquitous IRA subject to the limited "right to payment" exemption of §522(d)(10)(E). And one can certainly hope that Congress will act in the near future to bring the protection afforded ERISA-qualified plans and IRAs into conformity with each other.

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Footnotes

¹ See Pryor, C. Scott, "May It Please the Court: Some Answers to Questions Not Raised in Rousey v. Jacoway (Part 1),: ABI Journal, February 2005 at 40. Return to article

² Bankruptcy Code §522(d) reads as follows:

(d) The following property may be exempted under subsection (b)(1) of this section...

(10) The debtor's right to receive—

(A) a social security benefit, unemployment compensation or a local public assistance benefit;
(B) a veterans' benefit;
(C) a disability, illness or unemployment benefit;
(D) alimony, support or separate maintenance, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor;
(E) a payment under a stock bonus, pension, profitsharing, annuity or similar plan or contract on account of illness, disability, death, age or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor, unless—

(i) such plan or contract was established by or under the auspices of an insider that employed the debtor at the time the debtor's rights under such plan or contract arose;
(ii) such payment is on account of age or length of service; and
(iii) such plan or contract does not qualify under §401(a), 403(a), 403(b) or 408 of the IRC of 1986 (emphasis added). Return to article

³ I will not "answer" all of the questions put to counsel at the oral argument. I have also taken the liberty of editing and reordering some of the Justices' questions in the interests of clarity. Return to article

⁴ Treas. Reg. §1.401(k)-1(d)(3)(i):

(3) Rules applicable to hardship distributions—(i) Distribution must be on account of hardship. A distribution...is made on account of hardship only if the distribution both is made on account of an immediate and heavy financial need of the employee and is necessary to satisfy the financial need...[and] must be made in accordance with nondiscriminatory and objective standards set forth in the plans.

"Immediate and heavy financial needs" include certain medical expenses, the down payment on the purchase of a home and certain educational expenses. See, generally, Treas. Reg. §§1.401(k)-1(d)(3)(iii)-(iv). Return to article

⁵ See, generally, Treas. Reg. 1.72(p)-1 for more details. Return to article

⁶ See Pryor, C. Scott, "Rock, Scissors, Paper: ERISA, The Bankruptcy Code and State Exemption Laws for Individual Retirement Accounts," 77 American Bankruptcy Law Review 65, 123-27 (2003) (listing state statutory exemptions for IRAs). Return to article

⁷ See 4 Collier on Bankruptcy ¶522.09[11] (2004) ("If the debtor's interest in the pension plan is included in the estate, the exemptions set out in §522(d)(10) are limited to the debtor's 'right to receive payment' under the plan"). Return to article

⁸ The Sixth Circuit Bankruptcy Appellate Panel considering this appeal reversed on the basis of the decision in In re Brucher, 243 F.3d 242 (6th Cir. 2001), even though the Brucher court had not considered the argument raised in Dale. See, also, Sheehan v. Morehead (In re Morehead), 283 F.3d 199, 206 (4th Cir. 2002) (construing identical state statute and concluding that the legislature "believed that the fully exempt benefits (for example, social security, unemployment compensation and veterans' benefits)...could be assumed to be no more than an amount reasonably necessary for the support of the debtor and his dependents") (emphasis in original). Return to article

⁹ The next sentence of the House Report makes it clear that it was the "benefits under a certain stock bonus, pension, profitsharing, annuity or similar plan..." that were to be exempted under §522(d)(10). H.R.Rep. No. 95-595, reprinted in 1978 U.S.C.C.A.N. 5963, 6318 (emphasis added). Return to article

¹⁰ See, e.g., Neavear v. Schweiker (In re Neavear), 674 F.2d 1201, 1206 n.12 (7th Cir. 1982) (social security benefits are property of the estate); Michigan Employment Sec. Comm'n. v. Jenkins (In re Jenkins), 64 B.R. 195, 198 (Bankr. W.D. Mich. 1986) (unemployment compensation benefits are property of the estate). Return to article

¹¹ "Many economists view pension benefits as deferred wages, in essence an agreement to delay the receipt of earnings that workers would otherwise demand currently for services being performed long before retirement." Dilley, Patricia E., "Hidden in Plan View: The Pension Shield Against Creditors," 74 Ind. L.J. 355, 411 (1998-1999). Return to article

¹² While IRC §408(a)((1) prohibits acceptance of excess contributions to an IRA, the sanctions for excess contributions run against the taxpayer. Treas. Reg. 1.408-1(c). See Boggs v. Commissioner, 83 T.C. 132 (1984), rev'd. on other grounds, 784 F.2d 1166 (4th Cir. 1986). Return to article

¹³ Footnote 5 of Patterson cited two circuit court opinions, both of which held that §522(d)(10)(E) applied only to the right to payment from pension plans, not the plans themselves. See Gladwell v. Harline (In re Harline), 950 F. 2d 669, 675 (10th Cir. 1991) ("§522 deals with distributions made from a pension plan and distributions which the debtor has a present and immediate right to receive") (emphasis in the original), and Velis v. Kardanis, 949 F. 2d 78, 81-82 (citing Clark). The Court's choice of authority, even in dicta, suggests openness to a plain reading of this statute. Return to article

¹⁴ See, generally, Borden, Michael J., "PSLRA, SLUSA and Variable Annuities: Overlooked Side Effects of a Potent Legislative Medicine," 55 Mercer Law Review, 681, 712 (2004) (listing reasons for shift toward defined contribution plans). According to Christiane Bird, "defined-contribution plans [as of Jan. 17, 2002]...have $2 trillion in assets, compared to $1.8 trillion for defined-benefit plans). This is a vast change from the mid-1970s, when defined-benefit plan assets stood at about $186 billion and defined-contribution plan assets at $74 billion." (quoted in Stabile, Susan J., "Another Look at 401(k) Plan Investments in Employer Securities," 35 J. Marshall Law Review, 539, 545 n. 27 (2002)). Return to article