The case itself focused on an Arkansas couple, Richard and Betty Jo Rousey, who declared bankruptcy in 2001. They had previously been laid off from their jobs at Northrop Grumman and had rolled over their employer retirement accounts into IRAs after leaving the firm. When the Rouseys claimed that the $55,000 in their IRAs should be protected from creditors in the bankruptcy proceedings, the bankruptcy judge and court-appointed trustee Jill Jacoway challenged, and the State and Appeals courts initially ruled against the couple. However, the Supreme Court ultimately was willing to hear the case, because of the substantial differences amongst the various circuit courts around the country in interpreting IRA bankruptcy protection.

In determining whether the Rouseys' IRA accounts would be protected under bankruptcy proceedings, the Supreme Court evaluated three basic tests under the Bankruptcy Code:

(1)  "The right to receive the payment must be from a 'stock bonus, pension, profit sharing, annuity, or similar plan or contract."

(2)  "The right to receive payment must be 'on account of illness, disability, death, age, or length of service."

(3)  "The right to receive payment may be exempted only 'to the extent' that it is 'reasonably necessary to support' the accountholder or his dependents.

The court held that the first provision was satisfied – IRAs "have the same primary purpose, namely, [to] enable Americans to save for their retirement" and, like other retirement plans, have a common feature in that "they provide income that substitutes for wages earned as salary or hourly compensation."

On the second test, the court ruled that the right to receive payment from an IRA is on account of age, referring both to the 10% early withdrawal penalty applicable to IRAs, as well as the age 70 1/2 required minimum distribution rules (and the associated 50% excise penalty for failure to take withdrawals).

These two tests were the point of contention between the Rouseys and Jacoway. Since both of these 'tests' were satisfied, the Supreme Court ruled in favor of the Rouseys.

However, it is notable that the third test was not even presented before the Supreme Court – ultimately, to actually protect their entire account balance the Rouseys will still need to prove how much of the account balance deserves to be protected as reasonably necessary for support. In general, extremely large account balances may still have 'excess' amounts subject to creditors, even with the granted IRA protection.

In addition, further limiting the scope of this ruling, not all states actually use the federal bankruptcy exemptions. In fact, some states have state-level bankruptcy exemptions (which, aside from the IRA issue, may be more or less favorable that the federal statutes). Consequently, in some states, the states exemptions must be used, in other states individuals have the choice of federal or state exemptions, and only in the remaining states must the federal statutes be used. Consequently, the ruling will only apply in states where the individual has a choice between state and federal exemptions and chooses the federal exemptions, or in states where the federal rules must apply, such as Alaska, Arkansas, Connecticut, Hawaii, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, Pennsylvania, Rhode Island, South Dakota, Texas, Vermont, Washington, Wisconsin, and the District of Columbia.

It is notable that this level of creditor protection is not the same as ERISA protection, which universally pre-empts state law and always provides creditor protection. It's also s questionable whether the ruling will apply to Roth IRAs, which have far fewer age-based restrictions (since contributions can be withdrawn penalty-free at any time, and no required minimum distributions apply during lifetime). Roth's thus would not meet the three-prong test evaluated by the Supreme Court.

The bottom line for advisers is that the Supreme Court's favorable allowing creditor protection for the Rouseys' IRAs is not a panacea for IRA creditor issues. The protection is not akin to ERISA-level protection, will only apply in a limited number of states, and will only apply to the extent reasonably necessary for support (which is still determined by the bankruptcy courts on a case-by-case basis). Consequently, decisions to complete IRA rollovers from ERISA-protected retirement plans must still be made carefully, depending on a client's particular facts and circumstances!

Michael E. Kitces, MSFS, CFP, CLU, ChFC, RHU, REBC, CASL, is Director of Financial Planning for Pinnacle Advisory Group, a private wealth management firm located in Columbia, Maryland. Michael welcomes your questions and comments at michael@kitces.com.