If you die before you’ve repaid your student loans in full, they obviously won’t be your problem anymore. But could college loans become a problem for your spouse, your parents or your children? Maybe. It depends on what type of student loan you have and what your lender’s policies are. And it could even lead to a tax bill.
Here’s an overview of the rules that apply to different situations.
Federal student loans
If all your student loans are federal student loans, good news: your loans must be discharged when you die, according to the Federal Student Aid Office of the U.S. Department of Education. Your survivors just need to give your loan servicer acceptable proof of your death, such as an original death certificate, a certified copy of the death certificate, or an accurate and complete photocopy of one of those documents. The types of college loans that fall into this category are Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct Consolidation Loans. Death discharge also applies to Federal Perkins Loans; the only difference is that since the school is the lender, you may need to provide the proof of death to the college. If the school has designated a servicer for your loan, the proof of death goes to the loan servicer.1
Parent PLUS loans
Parent PLUS loans are also federal student loans, but the parent is the borrower instead of the student. If the student dies, the parent will be relieved of the obligation to repay the loan upon providing acceptable proof of death to the loan servicer. If one parent dies but both parents are responsible for the loan, the surviving parent will have to continue paying it. If only one parent is responsible for the loan and that parent dies, the loan will be discharged.2
Private student loans without a cosigner
Private lenders’ policies on forgiving student loan debt if a borrower dies before repaying the loan vary depending on the institution and circumstances of the student loan. Many will discharge some or all of the student loan. For more information and examples, see the end of this article.
The best time to find information about a private lender’s policy is before you apply for a student loan or at least before you finalize the loan, so you fully understand the possible long-term financial impact of your loan. For loans you already have, your loan terms should state what happens to your loan balance in the event of the borrower’s untimely death.
If you can’t ascertain a lender’s policy, the safest assumption is that they won’t discharge the loan upon death. But if you’re shopping for a private student loan, try to get the lender’s policy in writing before ruling them out because you can’t find their death discharge policy online. Furthermore, keep in mind that your actual loan agreement, not something you find on a lender’s website, will be the final word on your loan terms.
Private student loans with a cosigner
Federal student loans usually don’t require a cosigner, but private student loans frequently do. The Consumer Financial Protection Bureau reports that about 90 percent of private student loans issued in 2011 had a cosigner.3
If the primary borrower of a private student loan dies, the cosigner may be required to continue making the payments. It can be a real hardship for some families; some have resorted to Change.org petitions asking banks to forgive a deceased family member’s student loan debt.
A private lender’s policy on a cosigner’s obligations after the primary borrower dies can also vary, depending on the institution and the student loan details. Some will let the cosigner off the hook. Wells Fargo, for example, states on its website, “In the event of the unfortunate death or total and permanent disability of the student, private student loan forgiveness will be available to any cosigners who signed the loan agreement. Loan forgiveness does not apply in the event of the death or total and permanent disability of the cosigner.”
If you have a private student loan account that does require your cosigner to keep making payments if you die, you have a couple of options for relieving your cosigner of that potential obligation.
One is to refinance your loans in your name only; this might be an option if your credit and/or income have improved since the time you took out the loans. Another option is cosigner release. Not all lenders offer it, but those that do will evaluate you similarly to if you were refinancing. Wells Fargo, for instance, states on its website that it “will evaluate credit and income factors to determine the student borrower’s ability to take full responsibility for repaying the loan.” Wells Fargo’s additional requirements for student loan cosigner release include making the most recent 24 monthly payments on time and not receiving loan forbearance or a loan modification for hardship reasons during that period. And PNC offers cosigner release after 48 consecutive on-time monthly payments.
Perhaps the biggest problem with having a cosigner on your private student loan account is that if your cosigner dies, the lender could call the entire loan due under the loan’s automatic default terms. The Consumer Financial Protection Bureau has fielded numerous complaints about this practice,4 which would seem to harm both the borrower, who is unlikely to be able to make such a large payment all at once and without warning, and the lender, who is unlikely to be able to collect the sum.
Income tax on cancellation of student loan debt
The IRS considers canceled debts to be taxable income, which means that even if a lender discharges a student loan balance when the borrower dies, his or her estate will have to pay tax on the value of the canceled debt. If the canceled student loan balance is $50,000 and the deceased taxpayer’s marginal income tax rate is 25 percent, his or her estate will have to pay 25 percent of $50,000, or $12,500, in federal income tax. State and local income tax may apply as well.
“For an estate, I am not aware of any situation other than insolvency where the estate would not recognize cancellation of debt income for the cancellation of a student loan,” said CPA and estate planning attorney Gregory Black, a partner at WeiserMazars, an accounting, tax and advisory firm in New York City. “All federal student loans and a number of private loans will discharge at the death of the borrower. In general, the cancellation of any debt, including student loan debt, must be recognized as taxable income,” he said in an interview.
Exceptions to the general rule include student loan debt that is discharged after working for a certain period of time in certain professions for certain employers — generally work for a nonprofit organization in the fields of medicine, education or law. The only other exclusion that would apply for an estate with cancellation of student debt would be insolvency.
The lender will send the borrower and the IRS a copy of form 1099-C showing the amount of debt that it canceled. IRS publication 970 talks about when canceled student loans must be included in taxable income and IRS publication 4681 details the rules for paying tax on canceled debts. If the deceased is considered insolvent, then the estate may owe less tax or no tax on the canceled debt by completing IRS form 982.
Student loan debt acquired during marriage versus before marriage
Whether you live in a community property state or not matters when it comes to student loans that you take out after marriage, according to Nolo, a major publisher of legal guides. In the community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin — a student loan that you take out when you’re married may be considered a community debt even if only the student signed as the borrower on the loan. That means a surviving spouse could be on the hook for a student loan after a partner’s death. For student loans that either spouse took out before getting married, however, the surviving spouse shouldn’t be responsible unless the borrowing spouse refinanced the student loan after marriage and added the surviving spouse as a cosigner.
“As with other debts in community property states, it generally does not matter whether or not a surviving spouse cosigned the loan, as long as they were married at the time the loan was taken out,” Black said. Since some student loan accounts discharge when the borrower dies, there may not be any remaining liability, even in a community property state, and some community property states have exceptions for debt incurred for education. “Any surviving spouse should check the laws of their state and how they apply to their particular situation,” Black said.
Matthew Carbray, managing partner with Ridgeline Financial Partners in Avon, Connecticut, said that in certain community property states, if assets are held in joint accounts, income from a spouse can be used to pay off student loan debts, even if the debt was incurred before marriage. “In equitable distribution states (most states, which don’t use community property laws), a loan without a cosigner would normally be the responsibility of one spouse only, though it would become taxable to the deceased spouse’s estate.”
Black added, “Even if a surviving spouse is liable for a student loan, it can never hurt to call the lender and attempt to negotiate a lower payoff amount.”
Purchasing life insurance to pay off your student loans
Carbray said his firm would recommend protecting a cosigner and any other beneficiaries with a small term life insurance policy.
Indeed, parents or students can purchase life insurance and the proceeds can be used to pay off private student loan accounts in the event that the student borrower, parent borrower or parent cosigner dies before the loan is repaid in full. A term life insurance policy equal to the full private student loan balance would prevent survivors from having any problems repaying the deceased’s student loan obligations. For loans that are discharged upon death, life insurance proceeds can help pay for any income tax due on the canceled debt.
Private lender debt policies: Examples
Here’s how some private student loan companies say they handle the borrower’s death.
ACS Nursing Student Loans: “Principal and interest installments may be canceled in the event of death. To claim this cancellation, the executor of the estate must submit a death certificate or evidence of death to the lending institution.” All NSL loans are eligible for cancelation of up to 100 percent of the loan balance.
Citizens Bank Student Loan for Parents: “In the unfortunate event of the student’s death or permanent disability, the Citizens Bank Student Loan for Parents will be forgiven.”
Discover Student Loans: Loans will be forgiven “in the event of the primary borrower's death or permanent disability.”
Darien Rowayton Bank (DRB): “DRB will forgive all of the amounts owed under the loan if the borrower dies.”
Earnest: “For all loans, in the unfortunate event of death or total and permanent disability, Earnest will discharge your loan.”
Purefy: “If a borrower lost his/her job, or there was an extraordinary circumstance (death, illness), we would absolutely work with the borrower on a case-by-case basis to determine the best remedy.”
Rhode Island Student Loan Authority (RISLA): Offers “loan forgiveness in the unfortunate event of student death.”
SoFi: “The company’s Community Loan Program for students and recent graduates will match the benefits of the government’s Direct Loan Program, offering borrowers income-based repayment options, loan cancellation in the case of death, relief for economic hardship and other advantages.”
SunTrust: “If the student borrower on a loan dies after disbursement of all or part of the loan and the loan has not previously become a charged off loan due to non-payment or bankruptcy, then the outstanding principal and accrued interest balance on such loan shall be forgiven if the servicer is informed of the student borrower's death and receives acceptable proof of death.”
Wells Fargo: “In the event of the death of the student, the loan will be forgiven and the borrower and any cosigner will not be responsible for repayment.”
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1 Federal Student Aid Office of the U.S. Department of Education, “Forgiveness, Cancellation, and Discharge: Death Discharge.”
2 Federal Student Aid Office of the U.S. Department of Education, “Discharge Due to Death.”
3 Consumer Financial Protection Bureau, “Mid-year update on student loan complaints,” April 2014, p. 3.
4 Consumer Financial Protection Bureau, “Mid-year update on student loan complaints,” April 2014, p. 3.