After you’re gone, your debts won’t be your problem anymore. But they will be someone else’s, because they don’t just go away.
“People tend to believe that either all of your debt dies with you or that your family members become responsible for all of your debt when you die,” said Leslie Tayne, an experienced debt resolution attorney in New York state. “Neither thought is totally wrong, but neither is totally right either.”
Here’s what really happens: Your debts become your estate’s responsibility when you die. The executor you name in your will becomes responsible for settling your estate, which includes settling your debts. Keep good records of your assets and debts so your executor will have an easier time handling them when you die.
Depending on how much estate planning you’ve done, your debts may reduce the assets that remain for your heirs. Types of debt to consider include:
From the outset, variations in state law can affect what will happen to your debts after you die.
How community property states handle debt after death
If you’re married, you need to know if you live in a community property state and how community property laws affect you. Forty-one states are common law (non-community property) states, which means “if Mom dies, Dad won’t owe Mom’s debts,” said Patrick Simasko, an elder law attorney, wealth preservation specialist, and owner of the firm Simasko Law in Mount Clemens, Michigan.
Nine states are community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. If a couple chooses, Alaska can also be a community property state. In these states, the law says both spouses share equally in each other’s income, assets, and liabilities — similar to a business partnership.
“If you live in a community property state, you are responsible for the debt that your deceased spouse took on during the marriage, even if you were unaware of the debt,” Tayne said.
Your estate is responsible for any medical bills you owe. If you’re married when you die, your spouse may be liable for your medical bills under your state’s family expense act.
If you are 55 or older and Medicaid is covering your bills, and if you are not survived by a spouse, a child younger than 21, or a blind or disabled child of any age, your state’s Medicaid program is required to ask your estate to repay the program for any nursing facility care, home- or community-based care, and related hospital and prescription drug costs Medicaid paid on your behalf. In some cases, such as when the estate has little value or Medicaid costs were minimal, the state may not seek repayment.
The government requires payment of any back taxes, plus any taxes owed for the year you die. These liabilities include federal, state, and local income and property taxes. An estate tax return may be required in addition to an individual tax return. State and federal estate tax laws differ, but at the federal level, IRS Form 706 is due when the decedent’s estate and lifetime taxable gifts are worth more than $11.58 million.
Final tax returns must account for all income earned that year up to the date of death. Any unfiled tax returns from previous years must be filed as well. (Some people are exempt from filing taxes in certain years when their income is low enough, however.) A surviving spouse, court-appointed representative, or certified personal representative, such as your estate executor, can claim any refund the IRS may owe you. The refund becomes part of your estate.
If your estate doesn’t have enough money to pay all your debts, federal taxes owed get first priority. If your estate executor doesn’t pay these debts first, the IRS can hold that person responsible to the extent of “the amount of any other payments made before paying the debts due to the United States.” In other words, paying your credit card bill before paying the government could be an expensive mistake for your executor. See IRS Publication 559 for more information.
Credit cards and personal loans
The estate is usually responsible for paying unsecured debt such as credit card and personal loan balances. When there’s a joint account owner or cosigner, that person will become fully responsible for any debts. A credit card’s authorized user will not.
If the estate has to go through probate, the debtors must file a claim on the probate estate, Simasko said, and if the estate has enough assets, all the debts will get paid. If the estate doesn’t have enough assets, the unsecured debts get prorated with the rest of the debts. If the debtors don’t file a claim, their claim is waived.
Since an auto loan is secured by the vehicle, someone needs to keep paying the loan if they don’t want the car to be repossessed.
In a community property state, a surviving spouse will be responsible for the loan even if their name is not on the loan or car title. In a non-community property state, a surviving spouse will not be responsible for the loan if they are not a borrower.
Similar to auto loans, mortgages are secured, so someone needs to keep paying the mortgage to prevent foreclosure on the home. It’s also important to stay current on property taxes and homeowners insurance. The executor may pay these expenses from the estate.
Thanks to a 1982 federal law, an heir can take over the deceased’s mortgage. If heirs can’t afford the mortgage, they can refinance, sell the home, or, if the home is worth less than the amount owed, they can let the bank foreclose. If the estate has enough assets, those assets could be used to pay off the mortgage. If other debts need to be paid but the estate does not have enough cash, state law may force the sale of the home so those debts can be paid. However, homestead exemptions may protect the home from being liquidated to repay unsecured creditors.
A reverse mortgage must be repaid when the last surviving borrower dies. The loan is usually repaid by selling the house. If the house is worth less than the loan balance, the lender takes the loss. If the home is worth more than the balance owed, the estate receives the excess proceeds from the sale. A nonborrowing spouse may not receive additional proceeds from the reverse mortgage and may have to move out.
The rules about what happens to student loans after you die depend on whether the loans are federal or private. Federal Direct Subsidized Loans, Direct Unsubsidized Loans, Direct Consolidation Loans, Student PLUS Loans for graduate and professional students, and Perkins Loans are discharged when you die.
What about Parent PLUS Loans? If the student dies, the loan is discharged. If the parent responsible for the loan dies, the loan is discharged. If the loan is in two parents’ names, the loan is discharged when the second parent dies.
Private student loans usually have a cosigner, who may become responsible for repayment when the student dies. Private lenders have varying policies about what happens to this debt after death. (Learn more: What happens to your student loans when you die?)
Promissory notes to friends, families, or business partners may seem less serious than loans from financial institutions, they are legally binding if drafted correctly. The estate will need to pay these. The estate may also need to collect on any loan the deceased made via promissory note unless the will specifies that these loans be forgiven.
Debts that have gone to collections
The Fair Debt Collection Practices Act protects the family of the deceased against abusive, unfair, and deceptive debt collection practices and lays out whom debt collectors can contact and how often. Family members usually are not responsible for a deceased relative’s debts, except in situations such as cosigned debts and debts in community property states.
Relatives have no legal or moral obligation to pay debts that the estate’s assets can’t cover, Tayne said. But be careful.
“Creditors will call and try to get you to pay by trying to guilt you into ‘doing what your loved one would want,'” Tayne said. “After death, there is a vulnerability for those left behind, so not making quick decisions and working with a professional to guide you through the process of winding down the affairs of the decedent is key.”
Life insurance policy loans
With whole life, permanent life, or universal life insurance policies, the insured may be able to borrow against the policy’s accumulated cash value during the course of life. Policyowners can tap the cash value of a permanent life insurance policy for any reason — a down payment on a house, college tuition, or supplementing retirement income.1 (Learn more: Life insurance: Treat cash value with care)
But any such outstanding loans and interest must be repaid from the policy’s death benefit when the insured dies. As a result, cash value loans can reduce how much heirs receive from a life insurance policy. (Calculator: Do you have enough coverage?)
Using life insurance to protect heirs from your debts
In the end, if your estate doesn’t have enough money to repay all your debts, the relevant state law determines which creditors get priority.
But life insurance can make sure your heirs receive something when you die no matter how much debt you have. The death benefit your child receives from your life insurance, for example, is not considered part of your estate. It’s not subject to taxation, and creditors can’t claim it to cover your debts.
Other tools are available as well. Adding transfer-on-death designations to keep financial accounts out of probate and to transfer assets directly to beneficiaries is another way to reduce the impact of debt on your estate and protect your heirs. Revocable living trusts, another popular estate planning tool, will also keep assets out of probate, but it will not protect them from creditors.
Many people opt to talk with a financial professional about what estate planning provisions may be appropriate as well as the possible life insurance options available to help manage debt obligations for the estate.
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1 Borrowing from cash value will reduce the policy's cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.