Estate Planning

When we die, we leave a legacy. For many, a part of that legacy is debt.

So, what happens to debt after death?

It depends on the type of debt and where you live. Mortgages and auto loans are treated differently than credit card debt and student loans. Checking and savings accounts are treated differently from life insurance and retirement accounts as parts of the entire estate, and debt collectors are likely to introduce themselves quickly. So, preventing debt for your heirs to deal with is important.

First, it helps to know about the process of settling your financial affairs. The assets someone has at death are called the estate, and outstanding debts the deceased left behind have to be paid before the heirs get money, something that may involve probate court.

How Probate Court Works

Probate is the legal process for establishing the validity of a will, determining the deceased person’s assets and applying state law to distributing those assets to heirs, creditors and, in case of taxes, the government.

After death, an executor will be put in charge of finding, securing and managing the estate’s assets. If you have a will, it should name the person you chose for that role. If there is no will, the probate judge appoints an administrator. The representative provides a list of your assets, debts and who is to inherit the estate. That may require parts of the estate being sold to produce the cash needed to pay creditors and then heirs.

First, the executor must determine if the estate has enough money to pay all your bills and debts. The assets include savings, property, uncollected loans owed to the deceased, final paychecks, life insurance payments and retirement accounts. Some property may need to be appraised. Likewise, debts are assessed, including, mortgages, lines of credit, taxes, loans, utility bills, phone bills and credit card bills. If the estate has more debts than assets, it is insolvent, and state and federal laws determine how to divide the money and which creditors get partial payments.

Note: If you co-signed a loan with the deceased, that debt belongs to you, not the estate, and you must repay it.

If assets remain after debts and taxes are paid, the assets get divided according to the will. If there is no will, the court might supervise the distribution of assets to settle disputes among the heirs.

Can Creditors Go After the Entire Estate?

Generally speaking, no. Assuming the accounts had a designated beneficiary other than the deceased person’s estate at the time of death, life insurance and payouts from IRAs, 401ks and other retirement accounts are safe. If, however, the life insurance beneficiary is dead, that benefit would likely go into the estate and paid to creditors. If the designated beneficiary had died, the retirement accounts may pass to the heirs-in-law if those are the terms of the account’s payment policies.

What If the Deceased Had a Mortgage and/or Auto Loan?

If you inherit a home that has a mortgage, federal law says the lender can’t force you to pay it off immediately as long as you keep making the payments. If there is a home equity loan on the property, the lender can force the inheritor to repay immediately, but it’s more likely lenders will let the inheritor to simply take over payments.

If it’s an auto loan, you will probably need to get the car transferred to your name and refinance the loan to keep making payments.

What Happens to Credit Card Debt When You Die?

In most cases, credit card debt after death must be settled by the estate. In nine states, the burden falls on the surviving spouses. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are community property states, which makes surviving spouses responsible for any debt incurred during the marriage, even if their name was not on the account.

Other exceptions are if you co-signed a credit card or had a joint credit card account with the deceased or if you were legally responsible for administering the estate and failed to comply with certain state probate laws.

What About Student Loan Debt?

Although debt is usually unsecured, these loans are sometimes forgiven at the death of the borrower, especially if they are federal student loans rather than from private lenders, which set their own policies. Some private lenders may seek the loan balance, which could come fully due when the student dies.

Preventing Debt After Death

Nearly three-quarters of Americans are in debt when they die, according to a 2017 Credit.com study, and they owe an average of $61,554. There are ways to help keep that debt from being a burden to your heirs. One of those is to avoid the probate court.

The best way to do that is to have a living trust because assets held in a trust are not subject to probate but are distributed according to the instructions in the trust. That saves beneficiaries time and money spent in probate.

Other tips:

Make sure you have a will that clearly says where assets will go. Make sure the beneficiaries are up to date; things may have changed since the will was written.

Speaking of beneficiaries, if there is a box on your IRA beneficiary list that says “per stirpes,” check it. This legal term means that should the intended beneficiary die before the person who made out the will, the beneficiary’s share of the inheritance goes to his heirs.

Since life insurance payments go beneficiaries rather than the estate, they will be taken care of should your estate be eaten up by creditors. Putting more money in IRAs and a 401k accomplishes the same thing.

Keeping organized records is important. Family members should be able to quickly access your credit card accounts and look up balances.

Debt, Death and Debt Collectors

The family grief may still be raw when the phone starts ringing with debt collectors seeking payment. It’s important to assess three things:

  • Is the debt valid?
  • Has the statute of limitations – the time limit for creditors to collect – expired?
  • Are you liable for the deceased’s debt?

Don’t take the collection agent or creditor’s word for it. On credit cards, a co-signer is liable, but an authorized user who didn’t sign the application but only had charging privileges, is not responsible.

Request that all communication come in writing. Make the request by letter and send it by certified mail, return receipt requested. If you think you’re being harassed for a debt you don’t owe or for an incorrect amount, send a debt dispute letter to the collection agency asking that the debt be validated. Federal law allows 30 days for you to respond with a letter after receiving written notice of a debt.

To be safe, have the executor or a family member notify the three major credit bureaus and ask them to put a “Deceased: Do not issue credit,” notice in the decedent’s file. As well, make sure your own debt is in order.

To sum it all up: The estate will pay pay the remaining bills and debts using assets like savings and property. Life insurance and retirement accounts are safe from creditors as long as there is a living beneficiary. In nine states, the burden of credit card debt falls to the surviving spouse. If you live in one of those states, a credit counseling session with InCharge can help you determine how to manage the new debt load.


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