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What happens to debt when someone dies? – Lucy, age 17, Cincinnati, Ohio
Imagine everyone has a large piggy bank that represents everything they own. Inside it are items such as cash in a bank account, a home, a car, clothing, jewelry, furniture, investments and other valuables. On the outside of the piggy bank are sticky notes labeled IOU – promises to repay borrowed money some day.
These IOUs represent the debt people owe others. Examples of consumer debt include credit card balances you haven’t paid off, outstanding car loans or home loans, unpaid medical bills and student loans.
As a finance professor who teaches and studies how money works, I can explain that most debts don’t disappear when the person who owes money dies.
Usually, executors manage estates
When someone passes away, their assets and debts become what’s known as an estate. Estates include everything that person owned, such as cash in bank accounts, any homes, boats, vehicles, clothing, jewelry, furniture, stocks, bonds, retirement accounts, intellectual property – copyrights, patents and trademarks – and other valuable things.
Then, someone is appointed to manage the estate. This person, called an executor, manages the distribution of anything left in the estate. In most cases, the deceased names an executor in their will, a document that spells out what should happen to their assets after death.
Going through probate
If no executor was named before death, or if someone was named but either cannot or will not serve, a special court that deals with estates, called a probate court, appoints an administrator to handle the estate.
If the person died without a legitimate will and has no living relatives, their property goes through a process called escheatment, where the assets pass to the government after debts are paid off.
When someone has written a will, their estate – with some exceptions – goes straight into the probate process. The court confirms the will, appoints the executor and ensures that all debts and taxes are paid off before the remaining assets are distributed to people and organizations known as beneficiaries that the person who owned the assets named in their will. They may include any combination of relatives, friends and charities.
The executor looks at everything the deceased had left and adds up its total value. Next, they identify and total all debts and use the estate’s assets to pay off its debts.
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As long as the estate’s assets are worth more than its debts, beneficiaries receive money and other items of value from the estate.
If someone dies without a will, they are considered intestate. In that case, the probate court appoints an administrator, often a close relative, such as a spouse or child. Later, the contents of the estate are distributed to the deceased’s relatives in accordance with state law, even if this differs from the deceased’s unwritten wishes.
In some cases, this process can take many years, and even decades, to wrap up.
When the piggy bank falls short
There are times, however, when estates are insolvent, meaning that their debts are worth more than their assets. That means they can’t afford to cover all of their IOUs. In such cases, some creditors – the people or companies owed money – may not be paid in full.
Importantly, relatives of a deceased person are not responsible for paying off any remaining debts with their own money.
However, the estate may end up using funds it would have otherwise inherited to pay off the deceased person’s outstanding debts.
And there are some situations in which others may still be responsible for repaying those debts, especially for bills tied to the medical treatments they received as part of their end-of-life care.
Different rules in some states
For example, a deceased person’s spouse may need to help pay debts if they are what’s known as a cosigner for the medical treatment or if they live in a community property state, such as Arizona, California and Texas, where spouses share ownership of most assets and debts acquired during the marriage. Some states have filial responsibility laws that could require adult children to help pay a deceased parent’s unpaid medical or nursing home bills, though these laws are rarely enforced.
Also, if someone agreed to take responsibility for a debt while the deceased person was alive, they may still be required to pay it. Furthermore, if that person shared a credit card with someone else, the surviving cardholder is typically responsible for any remaining balance. This law depends on the type of account held and may vary in some states.
If the deceased had a mortgaged property, their beneficiaries can keep it – as long as they continue to make the necessary payments. Families and friends in that situation can also sell homes and use some or all of the proceeds to pay off the loans.
When a property is underwater – meaning it’s worth less than the remaining home loan – the lender takes the loss on the unpaid balance. Heirs are not personally responsible for the deceased’s home loan, but the lender will first seek repayment from the estate.
Financial data shows that about 73% of Americans die with some unpaid debt. Each year in the United States, about 160,000 to 340,000 people die with more debt than assets. But this situation might change within two or three decades as younger Americans inherit an estimated US$110 trillion after the death of today’s older generations.
Although this topic is sad, it’s a good reminder that having money comes with responsibilities and that planning ahead can protect your loved ones. I also think that understanding how things work, even after death, can make what you need to do in your lifetime much clearer and less overwhelming.
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