Written by: Amber Westover | Best Company Editorial Team
Last Updated: August 13th, 2020
The last thing you want your children to inherit is your unresolved debt. Unfortunately, unemployment, medical emergencies, and an unexpected recession can drain your savings and leave you with unpaid bills. The fate of your debt, after you die, largely depends on the type of debt, your state, and the overall nature of your estate.
Solvent vs. Insolvent
When a person dies, the deceased's total combined assets form an estate. Estates are either deemed solvent or insolvent. Solvent estates have enough money to pay off all debts and allow some inheritance for beneficiaries. Applicable assets go through a probate process. Debts are first paid off with money from the estate, then beneficiaries receive the remaining sum according to the estate plan, or law if no plan was created.
On the other hand, an estate is declared insolvent when assets are insufficient to pay off all of the deceased's debts. In this case, the estate is used to pay off bills according to federal and state laws. Some creditors will be paid in full, some will receive partial payment, while other debts will remain unpaid. In most insolvency cases, heirs and remaining family members are not responsible for debt.
Certain types of accounts are excluded from the probate process. Life insurance policies and retirement accounts are typically paid directly to the beneficiaries. In addition, certain bank accounts, like those set up as payable upon death, will also go directly to the designated beneficiary. However, if the beneficiary dies first, the accounts may be included in the estate.
In several cases, children, spouses, or parents will be held responsible for outstanding debts.
Cosigners: If you cosigned an account or a loan, you will be held fully responsible for the outstanding balance.
Joint Accounts: Typically joint account holders are responsible for the remaining balance.
Community Property: Several states have community property laws (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin, while Alaska is an opt-in state). In these states, the remaining spouse is often responsible for the remaining debt.
Specific Types of Debt
Five of the most common types of debt are mortgage, credit card, student loan, medical, and tax debt. Each type of debt has specific rules that govern how it is handled after death.
Mortgage: There are three standard outcomes for mortgages. The remaining spouse or heir can choose to take over the mortgage. The Garn-St. Germain Depository Institutions Act of 1982 prohibits lenders from demanding the immediate full payment of a mortgage, in many cases. A second option is foreclosure. The bank will sell the property and collect the remaining mortgage. Finally, the beneficiary can disclaim the property, and it will pass to the next beneficiary.
Credit Card: The outcome of credit card debt largely depends on whose names were on the account. If the deceased was the sole account holder, the estate is entirely responsible for the debt. No one is liable for the amount not covered by the estate. If the account had a cosigner, he or she is responsible for outstanding debt. However, an authorized user is not responsible. In community property states, the surviving spouse could be required to pay the debt. Unless an heir cosigned a card, and in some community property cases, collection agencies cannot collect money from surviving relatives.
Student Loan: There are two main types of student loans: private and federal. Federal loans are typically discharged upon the death of the borrower. This type of loan often requires confirmation of death through a death certificate. Private student loans are often collected from the estate first. However, they usually involve a cosigner, who may be required to pay the remaining balance. Additionally, in community property states, the surviving spouse may also be held liable for the loan amount. However, some private loan companies offer death forgiveness policies.
Medical: Like other debts, there are several different outcomes for medical debts. Often they are paid from the estate. When the estate is insolvent, some states still require surviving spouses to pay part or all of the debt. Sometimes a spouse will sign a guarantee of payment ensuring that medicals bills will be paid even if the estate is insolvent. Finally, in community property states the surviving spouse is usually held responsible for medical bills.
Tax: There are several different rules governing tax debt after death. The statue of limitations for federal taxes is ten years; ten years after the assessment date the IRS can no longer collect owed taxes. Prior to ten years the government can still collect taxes, even after death. Unpaid personal taxes are paid from the estate. However, if a tax return was filed jointly, the remaining spouse will still be responsible for the taxes, even if the estate is insolvent.
Deal with Debt Now
There are several solutions that you can use now to deal with your debt. One option is debt consolidation. You can get a free consultation and discuss your financial situation with a credit counselor. Companies, such as Consolidated Credit, will help you create a debt management plan and consolidate your debt into one, lower monthly payment. They negotiate with your creditors for lower rates. Through this process, you can eliminate your debt and help ease your family's financial burden after you are gone. BestCompany.com has ranked and reviewed top debt consolidation companies. Read real reviews and choose the one that best fits your needs here.
Prepare for the Future
Now is the best time to plan for your family's future. It is important to understand the laws that govern unpaid debt in your state, especially if you live in a community property state. In addition, you need to understand the nature of your accounts. Joint account holders and cosigners are often held responsible for debt.
Discuss your financial situation with an attorney. Find out if any of your assets will go directly to your designated beneficiaries. Ask about probate laws in your state. Once you understand the laws, you can plan to leave your family in the best possible financial situation.
For more information on what happens to debt after you die, check out SproutCents's article.