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When we die, what happens to our debt? Unfortunately, the debt we incur will not magically disappear. Most debt is settled using assets from your estate before it becomes the responsibility of your beneficiaries. During probate, the executor of the estate, using liquid assets of the estate, normally pays off debts before distributing any remaining assets in accordance with the deceased’s will. If there is not enough liquidity to pay debts, the executor may sell hard assets to successfully pay the debt.
The estate is considered solvent if it has enough money to pay off all its debts. However, if it does not have enough, it is declared insolvent. If the estate is insolvent, creditors may waive obligations that the estate is unable to cover. Most debts are paid off in the following order:
- Funeral/burial expenses
- Outstanding federal taxes
- Medical debt
- Property taxes
- Estate taxes; Legal fees
- Personal debt
Two Types of Debt
Debt that requires collateral, such as Mortgages and auto loans, is known as secured debt. If secured debt cannot be repaid, the property backing the loan will be seized to satisfy the balance.
Conversely, unsecured debt, such as Credit Cards and Student Loans, does not require collateral. If there is not enough money in the estate to cover the balance of unsecured debt, it may end up unpaid. The lender of this debt assumes the repayment risk. [i]
Family Inherited Debt Risks
Joint owners, Co-signers, and Authorized users
These accounts typically have “right of survivorship” which bypasses probate transferring the ownership upon one owner’s death.
A co-signer is legally obligated to pay the debt of another without having legal rights to own what the debt is on.
Authorized users on a credit card have been given permission to make purchases through the account. This permission does not carry any legal obligation to pay off the balance after death. This is because the authorized user did not formally agree to be responsible for paying off the balance. [ii]
Community Property
A community property state requires the equal division of all assets and debts acquired by spouses throughout their marriage. If one spouse were to pass, the other is now the owner of all debt. While divorce laws vary by state, community property law says if a divorce arises, the assets of the couple will be split fifty-fifty. Assets owned by either spouse before the marriage or after legal separation may not be classified as communal property. [iii]
Filial Responsibility
These responsibilities place an obligation on adult children, generally, to provide for the needs of their impoverished parents or other family members. Sometimes, other family members are given the responsibility. These responsibilities typically include medical expenses and events of long-term care. [iv]
Assets Protected from Creditors
When someone passes away, not all their possessions are inherited. The primary distinction between exempt and non-exempt assets established by legislation is that the exempt cannot be dissolved for debt obligations. Whereas non-exempt assets will be used to fulfil debt obligations. The most common exempt assets are retirement savings and life insurance policies. These assets go to named beneficiaries and are not included in the probate process. Life insurance benefits are often used to help family members cover debts that could be passed to them. [v]
Debt Collectors
Rules set by the Federal Trade Commission permit debt collectors to communicate with the spouse, parent, guardian, executor, or administrator of a deceased individual to address the debt. However, debt collectors cannot deceive family members into believing they oversee making the payments when in fact they are not. Although your family members can choose to not have a debt collector contact them, they are still obligated to repay the debt if they are the ones who caused it.[vi]
Lifestyle
Debt is an inevitable aspect of our way of life and every decision we make has an associated cost. In some circumstances, debt can be both essential and beneficial. For example, it can allow you to afford a home that you would not be able to outright pay for it. Of course, there are good and bad debts one can acquire but that is a topic for discussion in a later article.
Naturally, having a career in wealth management has led to a variety of questions from family and friends, all of which I am more than pleased to address. This article’s subject is no different. My friend Austin questioned me about what would happen to his medical debt if he passed away. At the time, I gave a short answer since it seemed like there was an even greater concern—fighting cancer. Fortunately, he has been in remission for two years, and I have since provided a more thorough response.
If you have questions or want to explore how this information might affect your estate planning, our team is here to help. Contact your advisor today to be sure your estate is in good order.
[i] https://www.forbes.com/advisor/personal-loans/secured-vs-unsecured/
[ii] Introduction to Authorized Signers (businessinsider.com)
[iii] Community Property States (investopedia.com)
[iv] North Carolina General Statutes § 14-326.1. Parents; failure to support. :: Chapter 14 — Criminal Law. :: 2005 North Carolina Code :: North Carolina Code :: US Codes and Statutes :: US Law :: Justia
[v] What Happens to Your Debt When You Die? – Forbes Advisor
[vi] Fair Debt Collection Practices Act | Federal Trade Commission (ftc.gov)
