What happens to your debts and other financial obligations after you die depends on the types of debts and obligations you have, your state's law about which debts are paid first, and how your assets are transferred at your death.
Types of Debts Your Estate Might Have to Pay
A few types of debt are canceled upon the death of the debtor, but most debts—as well as other financial obligations, like taxes—must be paid from the deceased person's estate. What does this mean? Your family probably won't need to reach into their own pockets to pay your personal debts. However, your outstanding financial obligations will be paid from the assets you leave behind, and these payments could reduce or eliminate gifts you planned to leave to loved ones.
Here's a quick summary of what happens to common types of debts and obligations:
- Mortgages: Loans attached to property (such as the mortgage on your home) must be paid. Usually the beneficiary who receives the property will also assume the property's debt. So if you leave your home to your niece, she'll receive it with the mortgage attached. If you prefer, you can also plan ahead and instruct your executor to pay the loan using assets you leave behind, and transfer the property free of debt, provided you have enough assets to pay it off.
- Car, boat, or recreational vehicle loans: Loans on a vehicle must also be paid. The person who receives the vehicle will also assume the responsibility for paying the debt, unless you provide a payoff for the loan in your estate plan.
- Credit cards: Credit card debt is the most common type of debt that people leave behind when they die. Generally, your estate will have to pay these debts, and credit card companies can be very aggressive in seeking payment. However, in some cases, credit card companies may write off some or all of the debt, especially if the estate doesn't have a lot of money. Also, some states give priority to surviving family members over credit card debt—which means that if the estate doesn't have enough funds to pay all beneficiaries and all creditors, some family members (such as a surviving spouse or dependent children) could be paid before a credit card company. See a local lawyer to discuss how your state will deal with your credit card debt after you die.
- Promissory notes: A promissory note is a written promise or contract to repay a loan—it is often used for loans between family members. What happens to a promissory note after the borrower dies? These loans must be repaid by the estate, unless they have been forgiven. If you repay a promissory note during your lifetime, make sure your executor has (or will be able to find) proof of your repayment.
- Leases: The terms of a lease will usually include provisions for the death of the lessee. Review the written contract and consult with an attorney if you have trouble understanding the terms of your lease.
- Business debt: Whether your estate must pay the debts from your business will depend on the structure of your business and whether you assumed personal liability for the debts.
- Income taxes: Your estate must pay any federal and state income taxes you owe at your death. This includes any back taxes you owe, as well as taxes on income you earned in the tax year of your death. For example, if you die in March, your estate could owe taxes on income you earned between January and March, as well as any income tax you owed from the previous year.
- Other taxes: Your estate must also pay any other type of tax you owe at your death, such as estate taxes and property taxes.
- Child support: If you die owing child support, the child's surviving parent or guardian or the state office that enforces child support may make a claim against your estate to recover the amount that you owe. Your estate's obligation to pay may depend on the terms of your support agreement.
- Federal student loans: Most federal student loans are discharged or forgiven when you die and do not need to be repaid. You can contact your lender to verify that your loan is a federal student loan and confirm what will happen to your loan if you pass away.
- Private student loans: Whether a private student loan is forgiven when you die depends on the terms of the loan. If the terms require repayment, your estate may have to pay that debt. If you have private student loans, discuss them with your attorney when working on your estate plan.
- Medical expenses: If you owe any outstanding medical debts when you die, the medical provider will likely make a claim for payment from your estate.
- Medicaid: If you receive long-term care services that were paid by Medicaid, the government may pursue repayment from your estate. Medicaid is funded by both the federal government and by the state, and each state has different rules about recovering assets. Some states are very strict and pursue as many assets as they can to recover the money, other states are more lenient. If you have concerns about Medicaid claims against your estate, consult with an elder law attorney for advice.
How Assets Are Paid After Death
Think of your estate as a temporary account that holds your assets while your affairs are being settled. The person responsible for wrapping up your affairs (often the executor you named in your will) gathers your assets, pays your debts, and then distributes any remaining assets to your heirs or chosen beneficiaries.
Debts Are Paid Before Assets Are Distributed
Generally, your executor must pay debts and other financial obligations before distributing your assets. So, although your heirs or chosen beneficiaries are not personally responsible for paying your debts, the amount of money or property they receive may be affected by the amount of your debt. If necessary, their share will be reduced to pay the debts of your estate.
Example: When Bob died, he had $200,000 in assets and $50,000 of debt. He is survived by four adult children. Bob's executor will pay the $50,000 in debt, and the money Bob's children will receive is reduced. Instead of receiving $50,000 each, after the debt is paid, each child will receive $37,500.
If you're worried about how your debts will affect what your beneficiaries receive, get help from a lawyer.
If Your Estate Is Insolvent, State Law Determines How Debts Are Paid
If your estate is insolvent—if it does not have enough funds to pay all of your debts and obligations—the executor must follow state law to figure out which debts to pay first.
For example, a common order of priority might look like this:
- the costs to take the estate through probate, including probate court filing fees and attorneys' fees
- funeral and burial or cremation costs
- federal and state taxes
- medical costs
- dependent family support claims
- child support claims
- all other debts.
When estate assets have run out, leaving creditors at the bottom of the list without a source of funds, your family will not be responsible for your personal debt. The debts will simply go unpaid.
Keep in mind that each state has different rules about the order in which creditors get paid, so get help from an attorney to find out how your debts would be paid under your state's laws.
How Assets Are Transferred Can Affect What Happens to Your Debts
Creditors may have an easier time getting to assets that go through probate, so you may be able to pass more of your assets to your beneficiaries by keeping your assets out of probate. For example, you can use beneficiary designations to name your loved ones (instead of naming your estate) to receive your IRAs, 401ks, pay-on-death bank accounts, or life insurance proceeds directly.
Example: When Cole died, he had $50,000 in credit card debt and a life insurance policy that paid $75,000 upon his death. If Cole names his estate as the beneficiary of the life insurance policy, the life insurance proceeds will be available for creditor's claims. If he names his daughter Riley as the beneficiary of the life insurance, those funds will not be part of the probate estate, and instead, the insurance company will pay Riley directly as the named beneficiary and this will make a creditor's claim more difficult.
One important exception here is that living trusts generally do not protect assets from your creditors. In fact, most revocable trusts (such as a simple living trust) instruct the trustee, the person responsible for managing the trust, to pay your debts at your death, or to coordinate payment of your debts with your executor. Further, some states require that a trustee file a "notice of trust" to make creditors aware of the trust and to give them a chance to assert a claim against the trust's assets.
Plan Ahead to Address Concerns About Debt
If you are worried about how your debt will affect your loved ones after you die, see a lawyer for help. A good estate planning attorney can help you:
- protect some of your assets from debt collectors
- name assets to pay specific debts
- determine which gifts should be reduced to pay your debts
- use life insurance to pay off all debts, specific debts, or to provide for a dependent
- make sure your beneficiaries receive life insurance payouts
- reduce your estate's overall liabilities
- forgive debts (like promissory notes)
- determine whether your estate will have to pay your lease, business debts, student loans, or Medicaid expenses, and
- plan how to leave your retirement accounts.
You should also see a lawyer if you have significant shared debts, such as joint credit cards or cosigned loans. In this case, the co-debtor or co-signer may be personally liable for the debt after you pass away.
Of course, you can also make efforts on paying off debt during your lifetime to minimize its impact on your estate when you die. For more help, see our section on Debt Management.