An Arizona resident is seeking guidance on how to invest an inheritance while protecting it in case of divorce. The woman, who wishes to remain anonymous, and her husband intend to use the funds to bolster their retirement savings. She is concerned about the implications of Arizona‘s community property laws.
The woman understands that in Arizona, assets acquired before marriage are considered separate property, along with inheritances and gifts received during the marriage. However, she wants to ensure that this inheritance remains entirely hers, even in an unforeseen divorce.
Financial experts recommend several strategies. Investing the inheritance in a separate brokerage account in the woman’s name only is one option. Another suggestion involves investing a portion in diversified mutual funds or exchange-traded funds. Diversification, across different asset classes, is emphasized as a crucial risk management technique.
The experts also cautioned against commingling the inheritance with existing retirement accounts. In Arizona, Individual Retirement Accounts (IRAs) are usually considered community property, meaning they are subject to division in a divorce. Similarly, contributions to employer-sponsored 401(k) plans made during the marriage, and any growth on those contributions, are also considered community property. Any contributions to a 401(k) made *before* the marriage, however, are typically considered separate property.
The process of dividing 401(k) accounts in a divorce usually involves a Qualified Domestic Relations Order (QDRO). While this process is standard, it highlights the importance of keeping the inheritance separate. Merrill Edge, an investment advisory service, explained that while early withdrawal penalties from a 401(k) generally do not apply in divorce settlements, taxes still apply to the distributed amount.
Experts also highlighted the different rules surrounding IRAs and 401(k)s regarding beneficiary designations. While surviving spouses typically automatically inherit 401(k) benefits, changing beneficiaries requires spousal consent. This further underscores the importance of keeping the inheritance separate from existing retirement funds.
George Bearup, a senior legal trust advisor at Greenleaf Trust, noted that even if an IRA is held solely in one spouse’s name, the other spouse may still claim a 50% interest in community property, even if the other spouse contributed 100% of the funds during the marriage. He explained that this community property interest can usually be transferred to the other spouse’s IRA without tax consequences. The advice reinforces the need to keep inherited assets separate.
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