What Happens to Debt When You Die?
Understand the financial side of death and 7 tips to protect your heirs.
I know it’s a depressing topic, but at some point you’ve probably wondered who picks up the tab for a dead person’s debt. Are you responsible for a parent’s debt after they’re gone, for instance? And will anyone inherit your debt after you depart this world? We’ll answer those questions and cover what you need to know about the financial side of death in this article.
What Happens to Debt When You Die?
The moment you die, something is automatically created. No, I’m not talking about a phoenix rising from the ashes or anything spiritual here. Your physical death gives birth to your legal estate, which is simply what you own when you die—no matter how big and fancy or how small and simple it is. The value of your estate is calculated by adding up all your assets, like cash accounts, investments, vehicles, and real estate, and then subtracting out the total of everything you owe.
Who Handles Your Estate When You Die?
After you die, someone has to handle the logistics of your estate. That person is called an executor and hopefully you’ve already named a trustworthy one in your will. A judge will appoint an executor for you if you die without a will. Probate is the legal process that an executor goes through to verify your will and to distribute your property. It can take a long time and involve lots of attorney and court fees, depending on the size and complexity of your estate.
The executor may be given permission by the court to sell your possessions, to pay your debts and taxes, and to distribute what remains to those named in your will. If you don’t have a will, your remaining property goes to your relatives according to a formula determined by the state in which you live. That means everything you own could go to family members that you haven’t spoken to in years. If you can keep some or all of your property out of the probate process, your heirs will thank you because your estate will be larger and they’ll receive an inheritance faster. I’ll give you tips about how to legally avoid probate at the end of this article.
Who Pays Your Debt When You Die?
So let’s get back to who pays your debts when you die. The money in your estate is used to settle debts that are in your name only. If there’s not enough money or assets to sell to cover them, then your creditors are generally out of luck. There’s nothing they can do if your estate is insolvent or broke. Debt in your name only doesn’t get passed to your spouse, partner, children, or siblings—it becomes the responsibility of your estate. However, if you live in a community property state and are married, your spouse may still be liable for debt accumulated during your marriage, even if it’s in your name only.
What About Secured Debts?
After your unsecured debts, like credit cards and medical bills are paid up, any remaining money and assets can be distributed to beneficiaries named in your will. It’s important to note that if you leave property that’s secured by a debt, like a house, car, or boat, to someone, they’ll be responsible for paying the debt.
I used to travel a lot for work and one time I overheard a conversation in an airport between two young women. One was telling the other that when someone dies and leaves you a house that the mortgage just gets wiped away. I could barely hold my tongue—because that’s not true—but I had to rush off to catch my next plane. Obviously, people are confused or misinformed about this issue. Here’s the quick and dirty truth: If you leave your sister your house or a fancy car and she can’t afford to make the monthly loan payments, she’ll probably be forced to sell it to get out from under the debt.
How Debt on a Joint Account Is Settled After You Die
Now let’s talk about how debt on a joint account is handled after you die. If you co-sign for a credit card or a loan with your spouse or boyfriend, they’ll be responsible for the debt when you die. Each person on a shared account is responsible for the full amount, even if you made secret credit card charges the other person didn’t know about. That’s why agreeing to co-sign for a debt can be a really bad idea.
[[AdMiddle](I wrote a previous article titled Should You Have a Joint Credit Card or An Authorized User? to explain the differences between these two credit card options. The bottom line is that an authorized user can rack up debt in your name, but they aren’t legally responsible for it if you die because they don’t own the account. Your estate would have to pick up the tab for a free-spending authorized user.)
7 Tips to Protect Your Heirs
It’s easy to create ways to transfer money and property to your heirs so it legally stays out of probate. Here are seven tips to avoid the complicated and expensive probate process:
Create joint accounts. A joint bank or brokerage account passes directly to your co-owner.
Set up payable-on-death (POD) accounts. You can designate a bank account or a retirement account to be payable directly to a beneficiary after you die.
Set up transfer-on-death (TOD) accounts. You can designate a security, such as a stock, bond, or a mutual fund, to transfer directly to a beneficiary upon your death.
Set up transfer-on-death registrations and deeds. In a few states you can register a beneficiary for your vehicle and real estate so they’ll own it right after you die.
Own real estate jointly. Hold title to property so it automatically passes to a surviving owner when you die. Depending on where you live and whether you’re married or not it might be called joint tenancy, tenancy by the entirety, or community property with right of survivorship.
Set up a living trust. Property in a trust is not part of your estate for the purposes of probate because it transfers to a trustee. Then the trustee can easily transfer the property to your heirs.
Give gifts. If you give property away while you’re alive it doesn’t go through probate.
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