1. What debts is the estate responsible for?
The simple answer is that all valid claims against the estate must be paid. But if the estate does not have enough money to pay all claims in full, their payment is prioritized as follows:
- Expenses of administration (attorney fees, probate costs, compensation for personal representative)
- Funeral expenses (burial or cremation)
- Expenses of last illness (hospital, nursing home, physicians)
- All others (secured and unsecured creditors)
Expenses of administration are always paid first. If there are multiple claims within a category and not enough funds left to pay them in full, the claims must be prorated according to their amounts.
2. What debts are the survivors responsible for?
If the estate cannot pay all the valid debts of the deceased person, the next question is whether the surviving beneficiaries are responsible to pay them.
If the deceased person was unmarried, no one else is responsible for payment of the debts. There are some important exceptions. If another person agreed in writing to be responsible for payment of the debt, then that person continues to be liable for the entire payment. The debt should be paid first out of any joint accounts that the deceased person shared with the other debtor, and if that is not sufficient, then the other debtor must pay out of his or her own funds.
If the deceased person was married, the answer is much more complicated. For a separate debt of the deceased spouse, up to one-half of the community property (representing the deceased spouse’s one-half) is available to pay the debt, along with the separate property of the deceased spouse. For a community debt, all of the community property, and potentially even the separate property of both spouses, is available to pay the debt.
A community debt is a debt incurred during the marriage, provided the expense benefitted the family directly or was used to care for family property. A separate debt is a debt incurred prior to the marriage or any debt not incurred for the benefit of the family.
3. Are any assets fully exempt from creditors?
Yes. Under Arizona law, up to $37,000 in statutory allowances is available to the surviving spouse and dependent children. These allowances take priority over all creditors except the expenses of administration.
Federal retirement plan accounts are exempt from creditors, with only one exception – if the deceased person owed back child support. In other words, the deceased person’s 401k or 403b account may be transferred outside the reach of the deceased person’s creditors. Individual retirement arrangements (“IRAs”) paid to Arizona beneficiaries are also exempt under state law, although there is a growing set of case law in other states that threatens to diminish the level of protection.
Life insurance death benefits are protected from creditors in Arizona. The amount of the exemption is unlimited, provided the beneficiary did not also agree to be responsible for the debt. However, Arizona law gives the surviving spouse and children up to $20,000 of claim-free life insurance proceeds even if they are also obligated to pay the debt. In other words, if a person dies insolvent but owned a life insurance policy, then a spouse or child can still inherit up to $20,000 of life insurance proceeds free of any creditor claims.
A surviving spouse may also qualify for a homestead exemption. This refers to the first $150,000 of equity in a primary residence. The surviving spouse may continue to enjoy the benefit of the homestead exemption, except a determined creditor could force a sale of the home if there is more than $150,000 in equity. The spouse would keep the first $150,000, but the balance would be available to creditors.
4. If the estate is insolvent, can a creditor make a claim against other assets transferred outside probate?
Yes, a determined creditor can request payment from persons who inherited an asset outside the probate process. For example, if Child inherited an account from Dad through a pay-on-death designation at a bank, a creditor of Dad could demand payment from Child. In order to do so, the creditor would have to deliver a written demand to the personal representative. The personal representative may then request Child to give back up to the entire amount received from the bank account to the estate. If Child refuses, the personal representative (or the creditor itself) can initiate a court proceeding to obtain a judgment against Child. This process is subject to the two year statute of limitations against creditor claims.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.