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What Happens to Debt When You Die?
Understanding Debt After Death and the Probate Process
“Creditors typically try to collect on unpaid debt, by going after the decedent’s estate during a process called probate.”
How Estate Organization Affects Unpaid Debts
When a person dies, it’s not unusual for them to leave behind some unpaid debt. What happens to that debt depends upon how their estate was organized, says the article “This is how your unpaid debts are handled if you pass away” from CNBC.com. The estate consists of whatever is owned, whether the person was wealthy or not. It includes financial accounts, real estate and personal possessions.
Surviving Spouses and Debt Responsibility
For surviving spouses, this can be worrisome. In most instances, they are not responsible for their spouse’s debt, but there are some exceptions. Here’s how it works.
Prioritizing Debts and Protecting Assets Through Estate Planning
The Role of Probate in Debt Settlement
Paying off all debts and then distributing the remaining assets is part of the probate process. Every state has its own laws regarding how long creditors have to make a claim against the estate. In some states, it’s a few months, in others it can last a few years. An estate planning attorney in your state will know how long the estate is vulnerable to creditors.
Assets That Bypass Probate and Creditors
In most states, funeral expenses take priority, then the cost of administering the estate, followed by taxes and hospital and medical bills. However, not all assets are necessarily part of the estate, and this is where estate planning is important.
Utilizing Trusts and Joint Ownership to Safeguard Assets
Life insurance policies, qualified retirement accounts and other assets with named beneficiaries go directly to the beneficiaries and do not pass through probate. The same goes for assets placed in trusts, as does jointly owned property, as long as it has been properly titled.
Community Property Laws and Shared Debt in Marriage
Impact of Community Property Laws on Debt Distribution
With the right planning, it is possible that an entire estate, including one that is insolvent, could be passed on to heirs outside of probate, leaving creditors high and dry. However, there are a handful of states that have “community property laws” that make debt more complicated.
Addressing Debt Forgiveness and Discharge
The law in these states views both assets and certain debt accumulated during the marriage as being owned by both spouses, even if it is only in the decedent’s name. That includes debt like medical expenses or a mortgage. However, that’s not the final word. A well-structured letter with a copy of the death certificate can sometimes lead to the debt being discharged. During the probate process, the company holding the debt should be advised that the estate has little or no assets to cover the debt and ask that it be forgiven.
Co-Signing and Student Loans in Estate Planning
The Limitations of Debt Forgiveness Requests
This does not apply to co-signing on a loan. Although the request can be made, it is not likely to be honored.
Federal Student Loans and Parent PLUS Loans
Federal student loans are forgiven if the student dies, which seems a matter of kindness. Parent PLUS loans, which are loans taken out by parents to help pay for education, are usually discharged, if the student or parent dies.
How Estate Planning Attorneys Help Protect Your Family
Structuring Estates to Minimize Creditor Impact
Your estate planning attorney can help structure your estate to protect your surviving spouse and family members from creditors.
Reference: CNBC.com (July 31, 2020) “This is how your unpaid debts are handled if you pass away”
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