As if it isn’t difficult enough to deal with excessive debt while we are living, many may wonder what happens to the “big black cloud” of debt when we pass away. Well, as is the case with all financial planning questions, the answer is…it depends.
At the time of a person’s death, it is the role of the executor of the estate to gather the assets and pay the deceased’s outstanding debts according to the state’s probate processes and laws. If there aren’t sufficient assets to pay the debts, the creditors may have to charge off the debt. If there are remaining assets, the debts must be paid prior to distribution to the heirs. Some assets bypass a will or probate (insurance proceeds, retirement accounts with beneficiary designations) and are therefore beyond the reach of creditors attempting to recover a debt through the probate process.
So what determines whether or not your estate or heirs are responsible for paying your debts?
- Where you live – Community property states differ from common law states when determining the disposition of debts incurred by spouses. No two community property law states handle “separate property” (including income) exactly the same way.
- Your relationships – In most states, relatives whose names are not on the account cannot be held responsible for debts, but surviving spouses may be (see above). With a “joint account” each account holder is liable for the debt regardless of who actually incurred the charges; however, an “authorized user” is not likely to be responsible for an outstanding balance at the death of the account holder.
- Type of debt– Not all debts are equal:
- Mortgage (secured) debt is attached to the property so, even after the death of the borrower, the property is still subject to the loan and the debt must be paid (either from the estate or other means) or the property forfeited.
- Student loan debt according to the Federal Student Aid website, may be discharged upon the student’s death, this includes parent (PLUS) loans taken on behalf of the student.
- Credit card (non-secured) debt is both simple and complicated depending on the account ownership AND the actions of the surviving family members. The simple part is that only the account owner or co-signer is responsible for the debt and the debt will be paid as part of the debtor’s estate. Things can become complicated when surviving family members don’t know the details of the outstanding debts and don’t understand their rights under the law.
- Some creditors will knowingly pursue family members who are not liable for the outstanding debt so it is important to know your rights and keep documentation on any accounts that you share with other people (family, friends or business partners). There are laws that govern and protect surviving family members from unethical practices. The Credit Card Act 2009 requires that creditors provide the executor of the estate the amount due within 30 days of the request and prohibits additional fees and penalties during the settlement of the estate.
- New Federal Trade Commission guidelines went into effect on August 29, 2011 allowing creditors to contact a wider universe of people in their debt collection efforts thus making it even more important to know your rights and obligations if you are a surviving family member. Although debt collectors are within the law to contact family members to locate the executor or administrator of the estate, they may NOT mislead the person into believing that they are responsible for the debt. Being familiar with the Fair Debt Collection Practices Act can help you better manage creditor contact.
Fortunately, there are financial planning actions we can take to avoid leaving our surviving loved ones with the burdens of our debt. Of course, we can avoid creating excessive debt or have a repayment plan if we already have debt or we can have sufficient insurance to guarantee that property we want to maintain in the family passes to our heir without a debt burden. We can also:
- Make an inventory of all debts and include details of the creditor, account number and contact information (be sure to update outstanding balances at least annually).
- List any joint owners or co-signers and make sure they know all of the details of the debt.
- Review all assets and verify or update beneficiary designations where appropriate.
- Put this information together with the will and other directives.
- Get professional help if necessary.
These simple steps can help manage this aspect of our financial life cycle and hopefully avoid leaving our families to bear the burden of our debt when they are most vulnerable.
President & CEO
Sage Financial Solutions
San Francisco, CA