Is an Inherited IRA Protected from Creditors in Arizona?
2023-05-31
Posted at 19:49h
in IRA, IRA Inheritance Trust
An Individual Retirement Account (IRA) is a valuable asset, and many people choose to leave their IRA savings to their loved ones. But even though retirement accounts are not subject to probate, they do face other risks.
There are no federal protections against creditors for inherited IRAs, and the state laws vary across the nation. Before leaving an IRA to your intended beneficiary, it’s important to understand what happens to the account if they ever get sued or file for bankruptcy.
Is an inherited IRA protected from creditors in Arizona? We answer that question below, and explain how to make sure that your beneficiaries get the most out of the account.
When Is an IRA Protected from Creditors?
A traditional IRA allows you to save up for retirement with certain tax advantages. Only the distributions (also known as withdrawals) you take from the account are taxed, while the funds can accumulate in the account tax-free. Generally, you don’t have to start making minimum withdrawals until you turn 72.
As long as the account isn’t inherited, an IRA is safe from creditors under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. However, the funds in traditional and Roth IRas are only protected up to $1,512,350, while other types of IRAs are fully protected. Non-inherited IRAs are also protected under the Employee Retirement Income Security Act.
Are Inherited IRAs Safe from Creditors?
An inherited IRA is simply an IRA that a beneficiary inherits from someone else’s estate. But unlike their own IRA, the beneficiary cannot make contributions to an inherited IRA. They can only make withdrawals, and must empty the account within 10 years after the account holder passes away.
Unfortunately, inherited IRAs do not have the same protections against creditors as other IRAs. In 2014, the Supreme Court ruled that inherited IRA funds would not be considered protected retirement funds, because there is no guarantee that the funds from an inherited IRA would actually be used for retirement.
This ruling made inherited IRAs vulnerable to the beneficiary’s creditors during bankruptcy and lawsuits. But while there are no federal protections for inherited IRAs, a handful of states currently have specific protections against creditors for inherited IRAs—luckily, Arizona is one of them.
How Is an Inherited IRA Protected in Arizona?
According to Arizona Revised Statute (ARS) 33-1126B, money from a retirement plan that is left to a beneficiary is “exempt from all claims of creditors.” However, if the beneficiary files for bankruptcy, this exemption does not apply to account contributions made within the last 120 days.
Plus, protections against creditors for inherited IRAs only apply if the beneficiary lives in Arizona. So, if you currently live in Arizona and inherit an IRA, or if you leave your IRA to someone who also lives in Arizona, then the inherited IRA will be safe from creditors.
However, if you leave an IRA to someone who lives outside of Arizona, or you live in another state and inherit an Arizona resident’s IRA, then creditors may be able to come after the inherited IRA, depending on the state laws.
In addition to Arizona, only the following states protect inherited IRAs during lawsuits and bankruptcy:
- Alaska
- Florida
- Idaho
- Missouri
- Ohio
- North Carolina
- Texas
What the SECURE Act Means for Inherited IRAs
In the past, the beneficiary of an inherited IRA was required to take minimum distributions from the account based on their life expectancy. However, the Setting Every Community Up for Retirement Enhancement Act signed in 2019 reformed this requirement. Now, the beneficiary is required to withdraw all assets from the inherited IRA within 10 years of the account holder’s death, instead of stretching the distributions across their lifetime.
However, the beneficiary of your IRA could recklessly withdraw and spend the funds in that time, instead of maximizing the account’s tax-free growth. Non-spouse beneficiaries are, in fact, able to withdraw the funds in one lump sum.
And although Arizona protects inherited IRAs from creditors, the account is vulnerable to divorce settlements during the 10-year period. Fortunately, there is a way you can protect the IRA to ensure that your beneficiaries get the most out of it, while also fully protecting it from lawsuits, bankruptcy, and divorce proceedings.
How to Protect an Inherited IRA
The best way to protect your IRA after you pass away is to set up an IRA inheritance trust. This type of revocable living trust is specifically designed for IRAs, and is set up separately from other living trusts. The IRA inheritance trust becomes the beneficiary of the IRA, while you remain in full control of the account during your lifetime.
When you pass away, the trust automatically becomes irrevocable, meaning that no one can make changes to it. The beneficiary’s creditors cannot come after the inherited IRA as long as it remains in the trust. The account will even be protected if the beneficiary gets divorced.
An IRA inheritance trust also gives you the power to dictate exactly how and when the assets will be distributed. So by placing the account in an IRA inheritance trust, you can ensure that your beneficiary only makes the minimum distributions until the end of the 10-year period.
Consult an Arizona Trust Attorney
The federal and state laws regarding regular and inherited IRAs are very complex, so it’s important to consult a professional estate planner before setting up a trust.
The Phelps LaClair team can help you create an IRA inheritance trust, and help you protect your IRA during your lifetime so it can benefit your beneficiaries. If you would like to learn more about how to protect an inherited IRA, or you want to get started with setting up a trust, call us at 480-892-2488 to schedule a free consultation.
Images used under creative commons license – commercial use (5/31/2023). Photo by Kelli McClintock on Unsplash
