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Court Upholds Bankruptcy Exemption For IRA Under California Statute

Bankruptcy debtors in California may shield their individual retirement accounts from creditors, the U.S. Court of Appeals for the Ninth Circuit ruled Feb. 14

2/14/00

Affirming decisions of a federal bankruptcy court and a federal bankruptcy appellate panel (In re McKown, Farrar v. McKown, 9th Cir., No. 98-15017 2/14/00), bankruptcy debtors in California may shield their individual retirement accounts from creditors, the U.S. Court of Appeals for the Ninth Circuit ruled Feb. 14.

When California residents Robert D. McKown and Dianna M. McKown filed a Chapter 7 bankruptcy petition, they claimed an exemption for an IRA account valued at $6,413. When the bankruptcy trustee objected to the IRA exemption, litigation followed.

In denying the exemption, the trustee argued that California law does not exempt IRAs from a debtor's bankruptcy estate, citing the statutory language permitting an exemption for "payment under a stock bonus, pension, profit-sharing, annuity or similar plan or contract" unless the plan or contract does not qualify under Internal Revenue Code Section 401(a), 403(b), or 408.

According to the trustee, an IRA is not "materially similar to the listed kinds of plans, such as pension and profit sharing plans."An IRA is "established by an employee, while pension and profit sharing plans are established by employers; an IRA is controlled by the debtor; the debtor can draw his money out of an IRA whenever he likes, but ordinarily cannot get money out of his pension or profit sharing plan until the employer, pursuant to the plan's terms, pays it to him; and an IRA established by the employee himself is not subject to ERISA," the trustee argued.

The McKowns countered that an IRA, like a pension or profit sharing plan, is a vehicle for retirement savings. They pointed out that premature IRA withdrawals are subject to a substantial penalty; that IRAs, like pension and profit sharing plans, have been given similar tax benefits by Congress and that other federal appellate courts interpreting the same language have exempted IRAs from bankruptcy estates.

Circuit Split Unnecessary

The appeals court found compelling the McKowns' argument that other circuit courts have interpreted the statutory language to exempt IRAs. According to the appeals court, California's exemption language is "materially identical" to the federal exemption and to similar state law exemptions in states that have elected to substitute their own for the ones in federal law. There is "no good reason to create a circuit split on exemption of IRAs from bankruptcy estates, particularly because at least one of the arguments for exemption is irrefutable," the appeals court said.

The appeals court said the irrefutable argument for exemption is that the language included in the federal, California, and at least one other state statute, excludes from exemption plans or contracts that do not qualify under tax code Section 408. According to the appeals court, Section 408 speaks only to IRAs. Therefore, the appeals court said that there "could be no reason for legislators to exclude non-qualifying IRAs from the exemption, as the exception does, unless they intended that qualifying IRAs could be exempt. Indeed, there could be no reason even to mention section 408, the IRA section, unless `similar plan or contract' included them, the court said."

The opinion was written by Circuit Judge Andrew J. Kleinfeld, and joined by Judges James R. Browning and Pamela Ann Rymer.

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