Most of us have some sort of vague idea about what happens to our assets when we die. The stuff we own gets passed on to the people we specify — assuming we’ve jumped through the right hoops. But what happens to our debts when we die? That’s what Matt wants to know. He wrote recently looking for clarification:
My parents are both in their sixites, and don’t have the best financial position. They have a significant amount of debt. I don’t know exact amounts, but I wouldn’t be surprised to hear they owe more money than they have in assets. Because their health is rather frail, I’m curious what could happen if they die and the liabilities (credit cards, mortgage, home equity line of credit) are greater than their assets (home, 401(k)s, life insurance). Do my sister and I get stuck with their remaining debt?
The short answer is no, Matt and his sister won’t be responsible for his parent’s debts. But that short answer isn’t very informative. Obviously, this isn’t really my area of expertise. For a bit more information, I contacted David Carlson, a local lawyer who specializes in estate planning. (Carlson is my lawyer.) Everything in the next section is Carlson’s response to Matt’s question.
Probate: Boring but important
What happens to your stuff when you die? The short answer is: It depends. The longer answer is: It depends on what the debts are and what the assets are. Consider the following scenario:
- Mom and Dad have two kids.
- They own a house worth $250,000 and have a mortgage on it for about $100,000.
- They own two cars that they owe about what they’re worth.
- Dad has a 401(k) account containing $100,000.
- Mom and Dad have credit card debit of about $7500.
Now assume that Mom and Dad are taking their first ever trip to Hawaii and the plane crashes. Both die simultaneously. Now what?
A probate is opened. Mom and Dad’s estate consists of their house, their personal stuff, and their two cars. It does not (usually) include the 401(k) (more on this in a moment). The mortgage company and the credit cards want to get paid. So do the people who loaned money on the cars. What to do? The easiest scenario is to sell the cars and pay off their debt. Then, sell the house and pay off the mortgage and the credit cards with the proceeds. Anything left over goes to the heirs.
Notice I didn’t say anything about the 401(k). That’s because retirement accounts (including IRAs, 401(k)s, 403(b)s, public employee retirement accounts, defined benefit plans, etc.) are usually governed by the contract that created them. In that contract, the owner of the account will have specified beneficiaries. Usually people name their spouse (you’re required to under ERISA), and then their children as alternate beneficiaries. In our scenario, if Dad did that, then the funds in the 401(k) go directly to the children and do not go through probate. That means they’re not subject to the claims of creditors.
But if we change the original scenario so that the house is worth only $200,000 and the mortgage is $250,000 (meaning that the house is upside down), then there’s not enough money in the estate to pay off the mortgage. Do the heirs have to pay this out of pocket? Absolutely not. The creditors of the estate can only get what’s in the estate. That’s it.
What if Dad screwed up and didn’t name a beneficiary for his 401(k) other than his now-dead wife? Then the money might go into the estate and be subject to creditor’s claims. It would depend on what the initial contract said. Sometimes the contracts say that the money goes to the children of the account holder. Other times they say that the money will go to the estate if there’s no named beneficiary. The bottom line is that you want to make sure your beneficiary designations are current.
A final note
Carlson also notes that there are tax consequences to beneficiaries who receive funds from retirement accounts. If you’re in a situation where you need more detailed information, contact your attorney or accountant. Your estate plan is nothing to mess around with; a lot of people ignore it until it’s too late, and many others make a mess of it because they haven’t stuck to legal guidelines.
That reminds me: Kris told me that if I didn’t complete my “death list” for her by the time she got home from work today, she might actually kill me. She’s joking of course, but all the same: I’d better step away from the keyboard and finally compile this information for her!
Thank you for the information
Off to fully fund our IRA’s for the year. We weren’t going to do it since we retired, but now I understand that the money is covered for our kids….AND it doesn’t count toward the tax on the estate itself (but is taxed in a different way).
I guess we should break down and see a real lawyer to work it through.
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Thank you for this. My parents debt often stresses me out! I don’t care if I get zero, as long as I don’t get their debt. Thanks for clearing that up! You just took a huge weight off my shoulders!
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This also bring up the important point of estate planning…which I admit I’ve only half started. This means creating wills, durable power of attorney, etc. Things need to be specified clearly to avoid probate and prevent squabbling among heirs.
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While you would not be legally or morally obligated to pay your parents debts, some collection agents will try very hard to bully you into paying.
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On a related note, if one spouse dies with a credit card balance on a card in one name only, the surviving spouse is not liable for that balance.
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Stuff like this makes it more visible of how the parents financial history affects the children when they die. meaning that will are very important for anyone to have before they die. And this is regardless of what age they are at.
Will are often associated with old age, but unfortunately, will are needed regardless of what age you are (assuming you are already legal of course).
It is always good to have a will because it gives you peace of mind of how your financial assets and debts are handled after you go away.
Even if it will never affect you personally, no one can ever emphasise enough the importance of wills. This is mostly from a psychological point of view.
Cheers,
Wahid
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Additional note. Probate it not always necessary. Additional note. Probate it not always necessary. For my mom’s estate we are looking into Affidavit of Heirship.
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It is so important to set up a trust and create a will (especially if you have children, you want to name a guardian in case both parents die). It isn’t fun, and it does cost money, but it is absolutely imperative. It is so much better to set things up yourself to minimize tax consequences instead of having money distributed based on intestacy laws.
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This is a great article.
What about life insurance? My mom has no assets, but significant IRS debts (has not paid her taxes in years). She also has a life insurance policy with me as the beneficiary. Will the IRS try to take this money when she dies?
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Good, plain English description of what can be a tricky subject. The rules on inherited IRAs/retirement plans are really complicated – definitely wise to pay a few hundred bucks and get a pro involved.
I’d love to see more articles like this at GRS. Thanks, JD.
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@Emily
The life insurance would be income tax free and depending on the amount free from the estate tax as well. I think the exclusion for estate tax currently is ~3.5 million so anything under that is not-taxable…however there have been a lot of changes in recent years and more to come so hard to say what will be in effect when she passes.
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Furthering the importance of a will…a designation of convervator and executor, power of attorney designation of guardianship (if your children are still little) and living will keep your assets out of probate~
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Thanks for this information.
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Sadly, US laws have decided not to recognize some families, so it is very important for those who are not “legally” married to consult an attorney who can help with tax and inheritance issues — and to do so early, not after some disaster!
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Great post, as usual. I think an important distinction to note is that a child is not responsible for a parent’s debt, unless the child is a co-signer. Then you’re on the hook. But if you never co-signed anything, you should be clear. A few years ago my husband wanted to cosign for his folks mortgage refi. I was adamantly opposed to it and thankfully, we didn’t do it. (Nothing’s happened to them, but the what-ifs were too much for me to stomach.)
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Good article, good comments, good questions. I too would like to see more on this type of thing, maybe a reader story?
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Great information but most important is to put your stuff in order, properly. At my age I have already seen some horrible situations my friends were left to deal with because their parents did no will or preparation. I now have a different take on “you can’t take it with you” no you leave “it” a big mess behind for your kids!
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@ Janette (#1) — The funds in 401(k) plans and IRAs ***are*** in fact subject to the estate tax. In 2010, there is no estate tax. However, in 2011, unless Congress acts to do something differently, the exemption amount for the estate tax will go from $3.5 million (what it was in 2009) back down to $1.0 million. So if a person who passes away has a house worth $750K and a 401(k) plan worth $500K, and no other assets or debts, $250K of that person’s total estate (total estate $1.25M) will be subject to estate tax (which in 2011 will be 55% — again, unless Congress acts to change the current setup).
Whoever inherits that house and whoever receives the 401(k) funds will also have to pay income tax when they sell the house or take distributions from the 401(k).
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I can’t help but point out that all of this stuff, and the probate and tax ramifications associated with it, are all truly unecessary. Everyone’s ultimate goal should be to die with no stuff or money left. Each remnant after your death is representative of waste. Excess waste is the result of poor financial management behavior and utter disrespect for the resources of the Earth, which are finite. Like Don Henley sang, “there ain’t no hearses with luggage racks”. Disassociate your well-being with your stuff and enjoy life!
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@Amy H
When you sell an inherited house, you will owe income tax in the form of capital gains tax only if the property has appreciated since the date of the person’s death. If there is no appreciation between the date of death and the date of sale (or if the amount of appreciation is less than or equal to the selling expenses), then there is no taxable capital gain, and you will owe NO income tax on the proceeds of the sale.
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“Everyone’s ultimate goal should be to die with no stuff or money left.”
Why? I work hard, I’m not wasteful, I enjoy some nice, high quality and expensive things here and there. If I would like to leave a small fortune to my children, on what grounds can you judge that to somehow be an immoral goal? I’m not trying to take anything with me, I’m leaving it for those who will be left behind for awhile.
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Yes, please – more info on this topic!!!
@ Holly p (comment 5) I think this depends on the state in which you reside. In the state of Washington, I think all debt is owned by both spouses if it is established within the marriage, period (it’s true for divorce proceedings, anyway).
My husband and I don’t have children and have no plans to do so. We don’t have wills set up. How necessary is it that we do so? I’d like to know more about probate. Please do a follow-up article!
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DC Portland – I take this to mean you believe that no-one should own anything? That is the only way to die with “nothing” left behind.
It’s an interesting (though, IMO, flawed)philosophical position but not really germane to this discussion.
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Wills are necessary for everyone who has any assets, or who might die in an event that will generate money. Otherwise, you leave everything in a colossal mess for the people you claim to love.
It is also your opportunity to express love and affection for some and to deliberately disinherit people who have no business with your assets, such as a drug-addicted parent or sibling.
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@19 DC Portland who wrote: “Everyone’s ultimate goal should be to die with no stuff or money left.”
————–
I generally agree with the idea of minimizing the accumulation of “stuff”, but money in the forms of savings and investments IMO are the antithesis of “stuff”. Those who have “stuff” have generally had to pull from potential savings or investments to obtain “stuff”.
One’s willingness to accumulate savings and investments over a lifetime at the expense of “stuff” enables him/her to provide a wonderful gift to his/her beneficiaries. What better way to show one’s love for family and friends than to make that kind of sacrifice?
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Today is open enrollment for benefits at my work.
Just updated my beneficiaries to include my son as secondary beneficiary on my work accounts. Even though he’s been around for more than 3 years, when I listed beneficiaries he didn’t exist yet. Thanks for the suggestion!
Also signed up for long-term disability for the first time in my life. The past year studying personal finance convinced me it’s important.
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We live in NJ. My mom died in credit card debt $20,000 without a will. We also owed the nursing home about $10,000 (we were applying for Medicaid when she died). She owned a condo without a mortgage worth about $100,000. I sent a copy of the death notice to all her creditors telling them that she passed away (period). Some accepted that and didn’t bother me. A couple made claims against the estate which took a long time to probate due to no will filed. We settled the nursing home for $5,000 and also settled some of the medical stuff. Once the house sold, my sister and I were able to split about $70,000. Bottom line, please, please get your wills, power of attorney and living wills done. Your children will thank you for it! Also, it wouldn’t hurt to have at least a small insurance policy to pay for funeral expenses. That also was paid out of the proceeds of the sale of the house, but I had to lay out money for all expenses until the house sold.
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I really appreciate this article. I admit I didn’t read all the responses but please be careful because funerals cost a lot of money and even the bare essential funeral can cost $6,000 on a low budget which must be paid before the person is even put in the ground in most cases. So even if you are covered with regards to their actual credit cards and other debt you could end up carrying a lot of other debt related to their funeral.
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On my spring break my junior year in college, I received the news that my coworker had suffered a stroke and was on life support. She had just turned 21. Because she had not created a will and was now considered a legal adult by the state, her parents were no longer able to make decisions regarding her health.
While I know this is a personal finance blog and the focus of this topic is debts and assets after debt, I’d encourage anyone to create the most basic of wills that give someone you trust the ability to make decisions on your behalf if for some reason you are unable to do so.
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Thanks for this article JD. Now for a possibly dumb question about spouses. If someone dies with lots of debt and no assets, what is the surviving spouse’s liability? Are they now responsible for all the debt?
Thanks.
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@14 elisabeth
Those families more than anyone else need to think more of this. Yes this is a personal finance blog, but since they are not allowed to be legally married because of corrupt politics, they must take care of their wills and all the legal stuff to their assets.
Sorry for my rant but great post and great comment. Wills need to be a lot more emphasised, it’s not something just for the more mature generation.
Cheers,
Wahid
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wow its scary having debt in your 60s, I really don’t know how these people will make it, I feel bad for their children :-/
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Interesting stuff and it is good to know and be aware of.
J.D.’s comment at the end could be a whole topic on its own. I handle everything related to our finances in our home. If I were to pass away right now my wife would be a bit lost as to how to handle everything. I better get to putting together my death list!
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The moral of this story is to crate an estate plan. My mother died three years ago (she was 48), and her estate was in probate for over a year. Creditors called my sister for two, and some still try to call her. She got her phone number changed. You don’t owe any of your parents’ debts, but the collectors will harass you to try to get some of the money. It’s sad, but it’s true.
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Did I miss the column on what a “death list” is?
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re. comment #25:
My husband is 60, I’m 58. Our 3 kids are 20, 23 and 27. We rent, have a 1999 van, no savings, no IRA, 401K and everything that comes in, goes out (rent is $985 and take home averages $1750).
We will probably price and make arrangements for the cheapest possible cremations.
We are an example of a new reality. We’re not leaving anything, but not necessarily by design. We see no point in trying to set money aside for our kids after we die. If we did have money, we’d rather help them when they need help, than leave them money when we’re dead.
I enjoy the blog, truly useful.
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His will stated that both boys would share equally. The 9 year old did not have a will for his half.
What happened??
The remaining son was just 12 & a minor & the wife long gone came back for her 2nd 1/2 (Commmunity Property in Washington State, so she got her 1/2 8 years prior) & now stood to recieve her 9 year old sons 1/2.
All because the will did not state: or his assigns – ie: passing on his 1/2 if unable to use it himself – giving all to the 12 year old.
Grandma continued raising the 12 year old, who today is doing aok due to loving family support and counseling along the way.
At attorney from your own state can be critical in setting up final wishes. Laws vary from state to state & you can’t write them out after the fact.
What 9 year old has a will?
It was a MESS at the time & effected many to this day.
Dot the I’s and cross the T’s folks.
Please
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@Diane (#35) (and the person whose comment I deleted accidentally on my iPhone this morning)
I’ve never done a column on the “death list”, though I’ve mentioned it in passing a couple of times. It’s basically a list of my accounts and account information. That way if I get smashed while riding my bike, Kris knows where to go to get my money…
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When my DM passed, she didn’t have enough in assets to require probate under my state’s laws. Her attorney told me that any legitimate bills were to be paid out of the assets she had, but I personally was not liable for any of her bills. (not that I expected any; she didn’t like debt.)
I know the attorney also ran a newspaper notice that she had died and that any creditors had until a specific date to make themselves known.
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For what it’s worth, I was trying to take an extreme position to make a couple of points that, I think, are often missed by people concerned about financial health.
1) A focus on the material (i.e. materialism)specifically, and consumerism, more generally, are counter to good financial health. Having “nice things” and “treating myself every once in awhile” are symptoms of the disease of materialism, which inhibits well-being and jeopardizes saving.
2) Acquisitiveness is partly to blame for the damage being done to our environment in the name of “progress”, “wealth”, “success”, and other monikers associated with super-capitalism. What “stuff” we pass-on to our heirs is of little use when they are forced to live in an inhospitable world. To truly benefit our heirs, we need to significantly reduce our consumption levels, and work toward cultural change that can increase the possibility that our heirs will thrive.
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One thing not mentioned is that a lot of student loans are forgiven upon death. For example, I owe about $75k on a Direct Consolidation Loan at about 3% interest.
If I died, my estate would not be responsible for it. Based on that and the low interest rate, I’ve decided not to make any extra payments on it… ever.
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Great information about the beneficiary designations. It’s amazing how seemingly insignificant items like that can make a tremendous difference.
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@ Trece- I have watched two grandmothers, two brothers in law, a father and my husband’s parents all die. None of them died quickly. The “fastest” was my sister in law- who had a heart attack after my husband’s brother finally succumb to his cancer of five years. She was died five days later.
All of these people had money for their care in the end.
I love my children, and feel they truly would do anything for me. As I for them.
I will make sure there is plenty of money, in the end, to help my husband and me through our final days- weeks- months and years. We already have a DNR after brainwaves are gone.
I don’t want to be at the mercy of whatever medical care is in place when we hit the road to the other side. If we don’t need it- put us in a cheap coffin and party on! The plot is already paid for!
Better get the cremation in writing. If you are a ward of the state you might be buried as well.
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Great post. Concise and and great plain language. Would love to see more of these, provided they are general and not state specific laws.
Just want to make a point for two of the comments I saw:
Depending on what state Holly P is in, she may be incorrect. In California, the short answer is that the surviving spouse is responsible for the deceased spouse’s debt.
Affidavit of Heirship is not an option for decedent’s estates exceeding certain amounts, e.g., $100,000.00
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@ Julie (#20) –
That’s usually true, but not for real property or other assets inherited in 2010.
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A really good book on inheriting IRAs – covering tax implications, beneficiary naming, and strategic withdrawals – is “Parlay your IRA” by Ed Slott.
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Thank you for clearing this up. I don’t know why no one believes me when I tell them that, generally speaking, you don’t inherit debt.
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My father in law died in March and he shared a house and everything with another guy.The other guy died in August.In his will he left everything for his sister to take care of and to split between his neices and nephew and my husband. He owed 60,000 on house and 6200 on car and had 20,000 in credit cards. We are having to sell house and everything in it to pay debts.It is sad to see that everything they bought is being sold and the family can’t get it. So, a Will is a good ideal. Just hope it dont take a long time to get it all settle and his sister can get all debt taking care of.
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