As more and more Americans struggle to save up for retirement and finance their end-of-life care, many surviving children will find themselves worried about the debt their parents leave behind. While debt does not die with its debtor, it also is not typically inherited. Unfortunately, it is going to become more common to die with debt.
An estimated 54 percent of Americans are struggling with some aspect of their financial lives. Rising healthcare costs, stagnating wages, and disappearing pensions are only further contributing to the trend. If you are worried about saddling your loved ones with your dues or are wondering if you will be held responsible for a spouse or relative’s debts, read on.
You (Usually) Cannot Inherit Debt
When a person dies, their debt does not die with them. However, there are limits to how it may be repaid. Most of us die with something left to our name, whether it is a modest sum in a bank account, a vehicle, a home, and other assets or properties. This is our estate, and it is what we leave behind for our relatives after death.
Debts are settled before an estate is distributed, which means that if a creditor comes to claim payment for a decedent’s debt, they may do so while the decedent’s estate is being probated. During the probate process, a local court legitimizes the decedent’s will and gives a representative or executor the right to distribute the estate among creditors and beneficiaries properly.
In some cases, this means that a decedent’s relatives are left inheriting nothing after all debts have been paid. In cases where an estate is insolvent, both creditors and relatives walk home mostly empty-handed.
Not everything we own goes into an estate and passes through probate. Certain accounts, assets, and properties may be given to loved ones automatically via beneficiary designations before a creditor can put a claim on them. With enough preparation, a person can put most of their estate in a trust designed to avoid debt collection.
There are rare cases where a person’s debt is transferred to someone else upon death. These cases usually involve loans, credits, assets co-owned or co-signed, and exceptional circumstances, some of which we will discuss below.
Probate, Direct Beneficiaries, and Debt
When a loved one dies, someone close to them must bring their death certificate and any relevant estate planning documents to the local courts. In cases where an estate is substantial enough to warrant a probate process (not all estates are), the courts will begin the process by legitimizing the will and naming a representative.
In the absence of a will, the courts will designate a representative responsible for distributing the estate as per state law (intestacy law). After taking inventory and making a valuation of the estate, the executor’s first job is to ensure that a public notice has been made notifying any creditors with outstanding debts to be paid by the estate. Creditors then have a finite period to make claims against the estate or send a bill.
Requests made outside of this period need not be fulfilled. Once an estate’s funds are depleted, the executor may have to sell the property to continue satisfying incoming claims. If the estate has multiple debts, then debts must be paid in a particular order, based on the priorities set by state and federal law. These may differ per state. A general guideline is that debts are paid in the order of:
- Fees (to the executor and probate attorney) and estate taxes
- Burial and funeral costs
- Federal tax debt
- Medical expenses
- Unpaid property taxes
- Personal debt (credit card and personal loans, etc.
Be sure to review the exact priority order for an estate’s debts in your state if you are an executor of a loved one’s estate. If debts further down the list cannot be satisfied with the estate’s contents, these debts are typically written off. Once all debts are paid (or at least those of claims filed within the appropriate period), the estate may be distributed as per the will or among living relatives as per intestate law.
Assets and properties that are marked pay-upon-death or transfer-upon-death typically cannot be claimed by creditors. These pass immediately to beneficiaries after a person’s death and are not part of the probate process (though they do count as part of the estate for tax purposes). Other examples of accounts with designated beneficiaries include individual retirement accounts and life insurance policies.
What About Irrevocable Trusts?
Living trusts are legal entities created via trust documents that hold assets and properties “in trust” for a beneficiary. Usually, when used for estate planning purposes, these trusts are built to distribute their contents to beneficiaries after death. While they do not pass through probate, assets held within revocable living trusts can be claimed by creditors. Irrevocable living trusts, on the other hand, can be written to protect assets from creditors.
But they represent another degree of separation from the trust’s contents and the trust’s creator and cannot typically be amended or undone. Because trusts can take some resources to create and manage, they may not be a realistic form of asset protection for most indebted estates. It may be in your best interest to speak with an estate planning professional about other forms of asset protection first.
Regarding Medical Debt and Filial Responsibility
Medical debt may become more common as healthcare costs continue to rise and our life expectancy continues to grow. However, unlike other debts, medical debt can be inherited. Close to 30 states have passed state laws that include “filial responsibility” statutes, requiring that a person’s children continue to pay for their unpaid medical debts if the decedent’s estate is insolvent.
This means if your parents have outstanding medical costs, such as hospital bills, and the estate’s assets are not enough to cover these costs, the hospital may continue to demand payments from you. The keyword is may. It is not always clear what is expected of you, and these statutes may not be heavily enforced in all states. If you live in a state with filial responsibility laws, consider consulting an attorney to determine what you are likely to expect.
Debt and Community Property
If you live in a community property state like California, and your spouse died, then you may be required to use the value of your home or property to pay your spouse’s debts. You are not liable for any debts that predated your marriage, however. Other forms of joint ownership may also lead to inherited debts. Co-signing a loan or being a joint owner of a property or account may lead to an inherited debt.
If you inherit a home with outstanding mortgage debt, you may want to contact an attorney to explore your options. You can take on the house and continue to make payments on it, or if the remaining debt exceeds the value of the home, you can consider selling it. The estate executor can also use assets to satisfy the mortgage so the beneficiary can inherit the home debt-free. Finally, executors may be personally liable for unpaid debts if the estate was distributed prematurely.
When to Seek Professional Legal Help
Aside from particular exceptions, people are not responsible for their relatives’ debts. If debt collectors are hounding you for a debt that is not your own, be sure not to make any sudden decisions. Do not agree to anything, and do not take on a debt that is not yours.
Contact a legal professional immediately and discuss your situation. Be sure to write everything down – the numbers and names of the people who contacted you, how often you spoke, and what kind of questions they asked. Being meticulous about the situation can help an attorney advise you on the right next steps.