What Happens to Your Debt When You Die? If You Run Out of Money, Are Heirs Responsible for the Bills?
A lot of retirees will run through their savings before they die. And then what? What happens to your debt when you die? Will your debts wipe out the assets you’d hoped to leave for your heirs? Will your family members be on the hook for your debt?
The short answer is, it depends on the type of debt you owe, whether there was a co-signer on the debt and whether you live in a community property state.
For the long answer, read on.
How is debt managed after death?
When you create a will, you designate an executor of your estate. That person is responsible for winding up your worldly affairs — including figuring out what happens to your debt when you die. The executor is in charge of protecting your assets until all debts and taxes have been paid, and transferring all remaining assets to your heirs. If you don’t leave a will, or no executor is named in your will, the probate court will appoint someone to be the administrator.
After death, your debts become debts of your estate. The executor must pay all creditors who file a claim, even if that means selling assets such as your home or other property. If there are not enough assets to cover the debts, the creditors will usually have to write off the remaining unpaid debt.
Certain accounts with beneficiaries, such as IRAs, 401(k)s, and life insurance policies don’t go through probate so they cannot be tapped to pay debts, although laws regarding what types of assets are safe from debt collectors vary from state to state. If the beneficiaries of life insurance policies are no longer living, the insurance proceeds may go to the estate, in which case they could be used to pay debts. For that reason, it is important to update your beneficiaries as circumstances change.
Credit card debt
Credit cards will typically be paid out of assets through by your executor. If the credit card had a cosigner, the cosigner would be legally responsible for paying off the balance. Authorized users on credit cards are not liable for any unpaid charges or interest. However, authorized users should never continue to use the credit card after the borrower dies. Since the authorized user is not responsible for paying the debt, continuing to use a deceased person’s credit card is considered fraud.
Certain states have community property laws whereby, in the absence of a prenuptial agreement, all assets and debts acquired by one spouse after the start of a marriage belong to both spouses. In community property states, even if the debt was in only one spouse’s name, if it was taken on during the marriage, the surviving spouse could be held responsible for the debt. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Keep in mind that probate laws vary from state to state, so discuss any specific questions with a probate attorney.
One word of caution on credit card debt: creditors don’t look kindly on “death bed gifts” financed with a credit card. There have been cases where a dying parent took huge cash advances from a credit card and gave the money to adult children shortly before passing away. In those cases, the creditor generally has the right to petition the court to reverse any gifts made within a reasonable “look back period” prior to the decedent’s death.
When someone dies and leaves behind an auto loan, the lender can repossess the car. If the loan balance is greater than the value of the car, the bank will write off the difference. If there is a cosigner on the auto loan, the bank will pursue the cosigner for the loan balance.
If heirs wish to keep the vehicle, they can simply continue to make payments on the loan until it is paid in full. Lenders will usually not take action unless the loan goes into default.
Federal student loans, including the Perkins and Stafford loans, are discharged upon death. Federal PLUS loans for parents will also be released if the borrower or student passes away with an outstanding balance.
Private student loans may be another matter. If the estate does not have enough assets to repay the loan, private lenders generally have no recourse unless there was a cosigner. In some cases, banks have pursued a co-signer after the student passed away. Several private student loan providers, including Wells Fargo and Sallie Mae, have given up this practice and will write off the loan when the student dies.
Other types of unsecured loans are handled similarly to private student loans. Any loan with a cosigner will become the cosigner’s responsibility. In the absence of a cosigner, if the decedent’s estate has enough assets to pay the outstanding debt, the executor must sell assets and pay off the loan. Otherwise, the lender will write off any remaining balance.
Mortgage and home loans
If your home is mortgaged at the time of your death, and your heirs would like to keep the house, they can choose to do so as long as there is enough money in the estate. Life insurance proceeds are often tapped to ensure beneficiaries can afford to hold onto the home instead of selling it to pay other debts.
Surviving spouses have a little more legal protection. A 1982 federal law allows them to take over the mortgage on a home without having to immediately pay the loan in full, although they may have to demonstrate creditworthiness and the financial capacity to keep up with payments.
Home equity lines have their own set of rules. In those cases, the lender can force the heir to pay off the loan immediately, even if that means selling the home. Some lenders may be willing to work with heirs to take over payments, as long as they can demonstrate creditworthiness and the ability to pay.
Like credit card debt, unless someone has signed documents assuming responsibility for the decedent’s medical bills, the unpaid bills will be handled by the executor. The lender will write off the debt if the estate is broke.
Family members should be wary of signing paperwork while a loved one is in the hospital or being admitted into a nursing home. They may knowingly agree to cover the expenses, but occasionally, during that emotional time, family members may unwittingly agree to assume all responsibility for the medical debt.
Don’t pay what you don’t owe
Some unscrupulous creditors have been known to try to collect from spouses and heirs that are not responsible for the debt after a borrower dies. They may send legal notifications to surviving family members, make guilt-inducing phone calls, or threaten liens against the home of the surviving spouse unless the outstanding debt is paid.
Family members should not give in to these bullying tactics. The FTC has outlined steps that debt collectors can and cannot take when trying to collect on debts of the deceased. In short, debt collectors are only allowed to contact the executor or administrator of the estate to attempt collection. If you are not the executor or administrator and did not cosign on the debt, instruct the collector to call the executor and ask them not to call you again. If they persist, contact your attorney.
Like all of your material possessions, you can’t take your debt with you when you die. Thinking about what happens after you or someone close to you dies may not be pleasant, but understanding how debt works and being prepared with clear instructions for heirs is one of the best ways to ensure that your heirs aren’t haunted by your debt after you die.
Will you have debt?
One of the biggest goals of retirement planning is making sure that you can afford the rest of your life — preferably without debt.
You can find out if you will end up with debt after death by using a retirement calculator. The NewRetirement retirement calculator has some unique estate planning charts and analyses that show your debt after death and what assets you have that can be used to cover that debt.