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Money January 2013

Dollar Sense

What Happens to Your Debt When You Die?

By Teresa Ambord

In some states, certain assets cannot be touched by creditors. That is, they will not become part of probate (probate is the process of paying claims against your estate after you die). These assets can include life insurance proceeds, retirement benefits, and possibly real estate if the spouse is a co-owner on the mortgage.

Nobody is guaranteed tomorrow. If you have considerable debt, you may have wondered what would happen to your credit card bills, car loan, medical bills, etc. if you were to die unexpectedly. Will your kids or other next of kin end up paying your debts? Then there is your mortgage. It’s a common scenario these days for homeowners to owe more than the house is worth. If that is your situation, will you be leaving your heirs with a mortgage to pay off and a house they can’t sell?

Two experts weigh in on the question of what happens to your debt when you die. Austin Frye, a certified financial planner and estate attorney with Frye Financial Center in Florida, said you cannot pass your debt along to other people. So when you die, your personal debt generally dies with you. However, he added, it’s more complicated than it sounds, since there are a lot of exceptions.

For example, whose name is on the debt? Suppose you have joint credit cards with your spouse. The charges on a card may be exclusively your spouse’s, but if he or she passes away, you will be expected to pay the balance, and if you pass away your spouse will foot the entire bill. The same would be true for any other person you might share a card or other credit account with. Many parents add the name of an adult child to a credit card account in case of emergency, even if all the charges on the card are yours. If you don’t intend for your son or daughter to pay off your bills, you may wish to close any jointly held accounts now.

 

Community Property

Of course, if you live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, and Texas, Washington, and Wisconsin) all property and all debt acquired during a marriage is jointly owned. Suppose your spouse bought a midlife crisis little red sports car in his or her name only, and before it was paid off, your spouse died. Suppose also that you didn’t even know about the existence of the debt. You will have to pay the balance.

Note: The laws in community property states do vary somewhat from each other. If you have questions you need to consult a probate attorney who can advise you on state-specific laws.

 

More Debt than Money and Other Assets

Assuming when you pass away, you have assets as well as unpaid debts, the executor of your estate may need to sell your assets, explained David Mendels, a certified financial planner with Creative Financial Concepts (New York). Then he will use the proceeds to pay your debts to the extent possible. If the proceeds don’t cover your debts, the balance generally will be written off (unless there was a cosigner).

Your survivors will not be held responsible for any remaining debt.

Again, if there is a cosigner, that person will be expected to pay off the balance. “When you co-sign for something, you make a commitment to pay off that loan on the debtor’s behalf if they are no longer able to,” said Mendels. “That’s one of the many reasons people have to be careful about co-signing.”

Suppose your adult son cosigned on a balance you owe for a temporary stay in a nursing home. After you returned home, you worked to pay off the bills. However, before the debt was extinguished, you pass away. If a lot of time has passed since the debt was incurred, your son may not be aware that there is a balance remaining. But… he will be expected to pay off the debt.

 

More Money and Other Assets than Debts

Now assume you pass away with enough assets to completely extinguish your debts. If that’s the case, the executor of your estate will simply use your savings and other assets to pay those bills, and then distribute the balance to your heirs. If there is not enough cash, the executor will probably need to sell some of your assets, such as stocks, cars, and your house, to pay the debts.

“Creditors always come before heirs,” said Mendels. “All debts must be paid before the estate can distribute assets.” Creditors may be able to make claims against your estate if they believe there are assets that should be sold. However, in some states, certain assets cannot be touched by creditors. That is, they will not become part of probate (probate is the process of paying claims against your estate after you die). These assets can include life insurance proceeds, retirement benefits, and possibly real estate if the spouse is a co-owner on the mortgage. Some assets may be passed directly to the beneficiaries named in the will, which means that the assets are not included in the estate, and cannot be gobbled up by hungry creditors.

Again, details vary by state and the exceptions are many. If you are not sure your debts are covered by your assets, be on the safe side and consult a probate attorney in your state for advice.

 

Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.

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