Debt is a tricky issue at any time of life. However, it can become more complicated after a family member dies. You’re probably not sure what happens when a loved one passes away and leaves behind a bunch of debt. Who is responsible for settling them? Will you have to pay off your parents’ mortgage or credit cards? You’re already in an emotional state due to grieving. You really don’t need the extra stress of worrying about their financials too.
This is an important financial issue for many families. According to the U.S. Federal Reserve, Americans die with an average of $61,000 in debts. That’s a substantial amount of money! Some debts left behind do need to be reconciled. It can get complicated, but are on your side. Check out the following five tips that everyone should know when it comes to managing the debts of a deceased family member.
You Cannot Inherit Debt
Here’s the good news first. Debts left behind when someone passes away do not automatically transfer to the heirs. This means that you will not inherit the debts of any family member, regardless of relationship.
When people take out a credit card, line of credit, or other in their name, they are agreeing to repay the amount borrowed themselves. Whether a person is alive or dead, their debt obligations do not extend to their family members. Even spouses are not required to repay the debts of their partners in most cases. Basically, if you didn’t sign anything to attach your name to the debt, you’re off the hook. You may inherit an ugly painting from a deceased family member, but you will not inherit their bills.
There Are Exceptions to the Rule
While debt does not automatically transfer to the relatives of the deceased, there are instances where you could be on the hook for it. Family members (including spouses) are responsible for repaying debts if they co-signed for a loan or are joint account holders with the deceased person.
The important takeaway here is that if you are a co-signer on any debt, then creditors can come after you for repayment. Even if you never made a single payment on your grandma’s car. Or never even climbed behind the wheel. If you co-signed because the bank wouldn’t accept her smaller retirement income as enough for a loan, then the debt is basically yours now.
It is worth noting that spouses are not responsible for debts that were incurred. The most common of these would be student loans, for example. Keep this in mind and be careful about what documents you affix your signature to when it comes to family members.
Debts Transfer to the Estate
While your spouse and heirs may not be responsible for your debts when you’re gone, your estate is still responsible to resolve those obligations. Essentially, your estate is the property, money, and belongings that you leave behind when you die. In whole, it’s known as your Net Worth.
Most people itemize everything in their estate while they are alive in the form of a Will. When you pass, your estate is born. Most estates have someone designated as the “executor” or “administrator,” who is responsible to handle all financial issues of the deceased. That includes any debt they leave behind.
In most instances, debt obligations are settled first when someone dies. This will happen before there is any payout to the beneficiaries. This means any debt you leave behind can diminish the amount of money/property available to your heirs and relatives. In many cases, property you own (vehicles, real estate, other valuables) can be liquidated to payoff the debt obligations of your estate. Always remember that your debts do not vanish once you die. They will be left to your estate and its executor/administrator to resolve.
Never Promise to Pay
More good news though. If an estate doesn’t have enough worth to pay off its debts, the lenders are the ones stuck holding the bag. Although there may not be any inheritance to pass on, you are still not responsible for any outstanding debt if the estate runs short. We cannot stress this enough. Many pushy debt collectors will try to convince you to assume those debts, using threats or confusing language. NEVER AGREE TO PAY A SINGLE CENT.
There have been cases where heirs cave to the pressure, and say something like “Well, I’ll try to send you a little bit every month.” Some jurisdictions consider this a legally binding assumption of the debt. We’ve taken the liberty of preparing you a script, if you ever find yourself pressured to pay off the debts of a deceased family member.
Repeat after me:
“I will not be paying any of this debt, as I was not the one who signed for it. Unless you can prove otherwise, with a physical document containing my signature, don’t call me again.”
Then hang up. Repeat as many times as necessary.
Retirement Accounts and Life Insurance Are Protected
While creditors can go after your estate for repayment, there are some things they cannot touch. These include sheltered retirement accounts such as 401Ks and Roth IRAs, as well as life insurance benefits. That money will go to the named beneficiaries. They aren’t part of the probate process that settles debts owed by an estate. Life insurance benefits aren’t even subject to taxes in most instances, let alone available for creditors to touch.
The one exception is if the life insurance beneficiaries you name are no longer living either. In that case, your death benefit can revert back to your estate and be fair game for creditors. This is one reason why it is always important to keep your Will and named beneficiary information updated and current. If you can avoid it, do not have your life insurance pay out to your estate.
What if You’re the Executor?
If you’ve been given the responsibility to be the executor of someone’s estate, the rules aren’t really any different. You still don’t have to dig into your own accounts to pay any of the debts of the deceased. We’ve included this section for one important reason: keep all your personal finances completely separate from handling the estate.
By that, we mean any legal bills that result from probate should be paid by the estate. If you have to pay up front for some things, keep detailed records — and all the receipts. The law says that the estate will reimburse you. Again, it can be hard to stay business-like when dealing with the emotions of losing someone you loved. However, that’s exactly what disposing of an estate is — a business transaction. Treat it like one.
Community Property States Have Different Rules
The biggest exceptions to the rules outlined in this article occur if you live in what’s known as a “community property” state. These states include Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. In these states, half of any community (shared) property from a marriage can be put toward debt obligations after one spouse dies. Usually that means selling assets likes real estate or belongings that are considered “joint assets.” This is the reason that some trusting couples only put their cars or houses under a single name.
In community property states, one spouse can be liable for the debts of the other, even if they didn’t agree to them. They might not even know about them. There have been court cases where people have found themselves on the hook for the gambling debts of their dead spouse, even though they were completely unaware it existed. In a community property state, you could be responsible to settle any and all debts of a deceased spouse if you owned community property with them. Knowing the laws in the state (or country) where you live — and planning ahead — is critically important.