If you are concerned about incurring debt after a family member’s death or are worried how your own debt will impact your family, here are some things you should know.
First things first: At death, your assets become your estate. The process of dividing up debt after your death is called probate. The length of time creditors have to make a claim against the estate depends on where you live. It can range anywhere from three months to nine months. Therefore, you should get familiar with your state’s estate laws, so you are well aware of which rules apply to you.
Beyond those basics, here are some cases where debts are forgiven after death and others where they still must be paid, one way or another:
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1. Beneficiaries’ money is partially protected, IF they are properly named
If you or your loved one has completed a beneficiary form for each account — such as your life insurance policy and 401(k) — unsecured creditors typically cannot collect any money from those sources of funds. However, if beneficiaries were not determined before the death, the funds would then go to the estate, which creditors could go after.
2. When it comes to credit cards, what you signed is important
Unfortunately, credit card debt does not just disappear when you die. Usually, the deceased’s estate pays the credit card debt from the estate’s assets. Typically, children do not inherit the credit card debt — unless they are a joint holder on the account.
Surviving spouses are responsible for their deceased spouse’s debt if he or she is a joint borrower. Note this is different from an authorized user. Additionally, if you live in a community property state, you could be responsible for the credit card debt of a deceased spouse. It’s best to check your state laws. (A good resource is the Consumer Financial Protection Bureau.)
Even if you did not contribute to a credit card balance, if you signed a joint application for the card, you are liable to repay that balance if your family member passes. Again, this is not to be confused with being an authorized user on a credit card, which has different rules. Depending on the state you live in, you may not have to pay that balance.
If the estate has no value and the owner of the credit card passes, assuming there are no joint borrowers, the credit card company loses, and they write off the debt. If you lost a loved one recently, make sure to avoid using the credit card as it could be viewed as fraud, which makes the situation even more complicated. I suggest contacting the three major credit bureaus (TransUnion, Equifax, Experian) and have them flag the account as “deceased.” This should prevent further activity on the credit card.
I also suggest getting legal help if a creditor asks you to pay off a credit card. Don’t assume you are liable just because someone says you are.
3. Federal student loans are forgiven
This forgiveness applies both to federal loans taken out by parents on behalf of their children and loans taken out by the students themselves. If the borrower dies, then the federal student loans are forgiven. The same if the student passes, the loan is discharged. Proof of death is required, which may be an original or a certified copy of the death certificate.
For private student loans, on the other hand, there is no law requiring lenders to cancel a loan. Some loan programs offer loan forgiveness at death while others will charge the debt to the estate of deceased. It is best to check with the loan servicer.
4. Passing the mortgage on to your heirs
The word mortgage comes from the French mort for “death” and +gage “pledge,” as in payable to death. But it really should mean payable after death as well. If you leave a mortgage behind for your kids, under federal law, lenders must allow family members to take over a mortgage when they inherit residential property. This law prevents heirs from having to qualify for the mortgage. Heirs are not required to keep the mortgage, meaning they can refinance or pay off the debt entirely. For married couples who are joint borrowers on a mortgage, the surviving spouse can take over the loan, refinance, or pay it off.
If you inherit a property with a mortgage and can’t afford the payments, there are options, but theyl depend on the situation. For instance, was there a reverse mortgage? That may need to be paid off as well. Is the property underwater? If the mortgage owed is greater than the property value, that may pose problems. Did you inherit the property and mortgage with siblings? The house may be more valuable to one sibling than another. If that’s the case, then you may want to discuss equalizing the estate — one sibling inherits the house while the other keeps some other asset like the life insurance proceeds. It’s best to consult with the mortgage company, estate lawyer and other family members about possible workarounds. Mortgage payments will need to be paid, so it’s best not to procrastinate.
4. Marriage matters
If your spouse passes, you are legally required to pay any joint tax owed to the state and federal government. In community property states, you must abide by laws that make you — the surviving spouse — in charge of paying off any debt your partner acquired while you were married. That includes credit card debt, even on cards you might not have known your spouse had opened. There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. However, in other states, you may only be responsible for a select amount of debt, such as medical bills.
In an ideal world none of us would like to pass our debts onto the surviving spouse or children. But the reality is Americans use debt in a variety of ways, including student loans, credit cards and mortgages. If you can, use this time now to get your debts organized and evaluate how your survivors might be impacted if you pass.
This exercise may prompt you to buy more life insurance to pay for your debts at death. Or consider paying down the debts now while you are alive. Either path you choose, your next of kin, spouse, children and family members would greatly appreciate it. You might even say they would be in debt to you.
For more financial planning insights for Widows and Widowers, please visit my website at www.survivorplanning.com.
Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC. With 21 years of experience, Michael specializes in working with executives, professionals and retirees. Since he joined Summit Financial, LLC, Michael has built a process that emphasizes the integration of various facets of financial planning. Supported by a team of in-house estate and income tax specialists, Michael offers his clients coordinated solutions to scattered problems.
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