964. Laura reviews what happens to your debt when you die and tips for better estate planning.
964. Laura reviews what happens to your debt when you die and tips for better estate planning.
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Welcome back to episode 964 of Money Girl–I appreciate you downloading the show! I'm Laura Adams, an award-winning author, on-camera spokesperson, female money speaker, and founder of The Money Stack, my Substack newsletter. Subscribers automatically receive my Money Success Toolkit, which includes the exact templates I use to manage my finances.
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If you've ever wondered what happens to your or someone else's debt, like mortgages, student loans, auto loans, and credit cards, after you die, this post will review what you need to know. You'll learn about situations when surviving family members can and can't be held responsible for repaying creditors.
What is an estate?
After you die, everything you leave behind becomes a legal entity called your estate. It includes your cash, financial accounts, real estate, other assets, personal belongings, and your debts.
What happens to your estate depends on whether you die with or without a last will and the state where you lived. Probate is the legal process where a court reviews and validates your will and oversees the settling of your estate.
Every estate must have a named executor whose job is to distribute your property and pay your outstanding debts, like bills, loans, and taxes. If you don't create a last will with an executor, a court will appoint one for you. The problem is, they likely won't be someone you know and may not carry out your wishes as you would have liked.
Therefore, if you don't have a will, prioritize creating one. You can hire an estate planning attorney or use online resources like Trust & Will or Rocket Lawyer.
ALSO LISTEN: How do I create an affordable estate plan?
What happens to debt after death?
Many people have misunderstandings about what happens to their own or someone else's debt after death. Here are a few incorrect statements I've heard people say about debt after death:
None of those statements is 100% true. As I mentioned, a deceased person's debt becomes part of their estate. However, if you have federal student loans, they are automatically discharged or disappear when you die. But that's typically not the case for private student loans or any other type of debt.
Therefore, with the exception of federal student loans, if there isn't enough cash in your estate to pay off what you owe, the executor must sell as much of your property as possible to cover your debt. For instance, if there isn't enough to pay off your credit cards and personal loans, your executor may need to sell your belongings or non-retirement investments to cover them.
However, in most states, certain assets, such as funds in tax-advantaged retirement accounts, are safe from liquidation to pay creditors. Therefore, if you name your spouse or child as your 401(k) beneficiary, they would receive the money, even if your estate were insolvent or broke.
Creditors also can't go after property or cash that goes directly to someone else when you die, such as the beneficiary of your life insurance or an annuity. Those funds belong to your beneficiary and not your estate after you die.
After your executor pays your debts in a priority order set by state law (such as funeral expenses, taxes, and then other debts), they distribute the balance of your estate assets to any beneficiaries listed in your will, if you have one.
For instance, let's say you have a home with a mortgage, and your will says it goes to your son. If you die and he accepts the property, he will be responsible for the mortgage payments.
There's a federal law called the Garn-St. Germain Depository Institutions Act that allows a close relative who inherits a property to assume payments on the mortgage without triggering a due-on-sale clause. In other words, your son could title the home in his name and make payments, even if the mortgage remains in your name after your death.
However, if someone inherits your real estate and can't afford the expenses, including the mortgage, homeowners insurance, and property taxes, they will need to sell it or risk foreclosure from the lender.
Suppose an estate has more debts than assets. In that case, your creditors are generally out of luck, especially for unsecured debts, such as credit cards, personal loans, private student loans, and medical bills.
That should put your mind at ease if you've been worried about a family member racking up debt. If someone's estate can't cover the debt in their name alone, creditors cannot attempt to collect it from their family.
Creditors have a limited period, such as up to six months, to make a claim against an estate. It's against the law for a creditor to prey on a deceased person's relatives, hoping they'll feel duty-bound to pay a debt. Remember, the deceased person's estate is typically responsible for their debts, not you.
ALSO LISTEN: How do I create an affordable estate plan?
When are you responsible for debt after death?
There are situations where you may be responsible for someone else's debt after they pass away. For example, if you cosigned a debt, such as a mortgage, student loan, auto loan, or credit card, with the deceased, it will now be in your name.
Even if you never made a charge on a cosigned or joint credit card, you are still legally responsible for 100% of the debt. That's why cosigning should never be taken lightly.
Note that being an authorized user on a credit card is different from cosigning. For instance, if you're an authorized user on your dad's credit card and he passes away, you're not responsible for the debt, even if you made many charges.
So be clear about your credit card ownership status if a debt collector comes
knocking. Unless you're a cosigner on someone's account, their debts are not your problem.
However, an exception known as filial responsibility applies in certain states, which may obligate adult children to pay for a deceased parent's unpaid medical debts when their estate is unable to cover them. However, whether the law applies depends on factors like a parent's age and a child's financial situation.
If you have cosigned debts, a solution to ensure the survivor can repay them is to take out term life insurance and name the cosigner as your beneficiary. That would protect them financially if you die. However, there's no obligation to purchase life insurance to cover your debt after you die.
RELATED: Who should buy cash value life insurance?
What happens to debt after a spouse dies?
When you're married, what happens after the death of a spouse depends on whether you live in a common law or a community property state. There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In Alaska, spouses can opt into the community property system.
In community property states, money earned and property acquired by either spouse during the marriage are owned equally by both of you. Likewise, your debts are shared.
So, even if your spouse had a secret credit card in their name only, you'd generally still be responsible for the debt in a community property state.
However, property and debt you owned before the marriage are not considered community property. For instance, if you took out a private student loan before getting married, your spouse wouldn't be responsible for it if you died. Additionally, you can sign a legal document, such as a pre- or postnuptial agreement, to separate some or all of your community property.
In common-law states, debts in one spouse's name are not the responsibility of a surviving spouse. For example, if a deceased spouse's name is on a credit card that you didn't know about or on a car loan and title, you likely wouldn't be responsible for it.
However, there is an exception if funds were used for the benefit of the family, such as paying for food or childcare. In that case, you could be held responsible for 100% or 50% of the debt in a spouse's name, even in a common-law state. The treatment of debt after death can vary slightly, even among common-law states.
To sum up, with a few exceptions, such as being a cosigner or being married in a community property state, family members are not responsible for a deceased person's debts. So, never rush into paying a deceased person's debt from your own funds. Creditors may not receive payment if an estate has more debts than assets.
If you need help planning your estate, managing one for a deceased family member, or have questions about debt, consult with an attorney in your state.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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