Someone close to you dies and you are now the executor of the estate. You’ve never been in this position before and if you’re like many of my clients who have been faced with settling an estate, you’re a little panicked by the whole prospect—you’re staring into the great unknown with no idea of what it all entails.
One of an executor’s jobs is settling the debts left behind by the deceased. Do you start writing checks immediately? Are the debts get forgiven? What if there’s not enough money to pay everything off? What if creditors start calling?
The Estate is responsible
Dead or alive, a person is responsible for the debts they’ve accumulated. Once deceased, indebtedness becomes the responsibility of the estate and the person settling the estate is responsible for paying those bills.
Even though death has occurred, creditors still have a legal claim on what they’re owed and the executor has a responsibility to notify creditors. In some states it’s required that an ad be run in a local newspaper for several weeks to notify creditors of the loved one’s death and give creditors an opportunity to present their claim. It’s an important part of the process because heirs cannot receive their inheritance until the bills are paid.
While the estate is generally responsible for the debts of the loved one, there are some exceptions.
- If the debt is in the name of the deceased alone, the estate is responsible
- If there was a co-signer on a loan, the co-signer owes the debt
- If there is a joint account holder on a credit card, the joint account holder owes the debt. A joint account holder is different from an “authorized user.” An authorized user is not usually responsible for the amount owed
- State law may require a spouse to pay a particular type of debt
- State law may require the executor or administrator of the deceased person’s estate to pay an outstanding bill out of property that was jointly owned by the surviving and deceased spouses
- In community property states, the surviving spouse may be required to use community property to pay the debts of a deceased spouse. The community property states are Alaska (if a special agreement is signed), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin
If there was no joint account owner, co-signer, or other exception, only the estate of the deceased person owes the debt.
Under the Fair Debt Collection Practices Act (FDCPA), collectors can contact and discuss the deceased person’s debts with that person’s spouse, parent(s) (if the deceased was a minor child), guardian, executor, or administrator. Also, the Federal Trade Commission (FTC) permits collectors to contact any other person authorized to pay debts with assets from the deceased person’s estate. Debt collectors may not discuss the debts of deceased persons with anyone else.
Collectors are allowed to contact third parties (such as a relative) to get the name, address, and telephone number of the deceased person’s spouse, executor, administrator, or other person authorized to pay the deceased’s debts. Collectors usually are permitted to contact such third parties only once to get this information. The main exception is if a collector reasonably believes the information provided initially was inaccurate or incomplete, and that the third party now has more accurate or complete information. However, collectors cannot say anything about the debt to the third party.
More debt than assets
If debts exceed the deceased’s assets, state statute kicks in, which gives clear direction about who gets paid and how much they get. In terms of creditors, the Federal Trade Commission (FTC) says family members typically are not obligated to pay the debts of a deceased relative from their own assets. What’s more, family members – and all consumers – are protected by the federal Fair Debt Collection Practices Act (FDCPA), which prohibits debt collectors from using abusive, unfair, or deceptive practices to try to collect a debt.
Assets creditors can’t touch
There are some specific assets creditors cannot claim because they pass directly to the beneficiaries without ever becoming part of the deceased person’s estate and bypassing the probate process altogether. That being the case, heirs can’t be forced to use these assets to cover a deceased person’s unpaid debt. The key to determine which assets fit this description is whether they have a named beneficiary. Common examples include:
- Life insurance policies – Individual and Employer
- Traditional IRA
- Roth IRA
- Inherited IRAs
- 401(k) account at your current employer
- 401(k) accounts at previous employers
- Simplified Employee Pension (SEP)
- Simple IRA
- TSP account
- Deferred Compensation Employer Plans
- 457 Government Plans
- Health Savings Accounts
- 529 Education Savings Plans
- Transfer on Death (TOD) / Pay on Death (POD) accounts at banks, investment firms, savings, and loans, or any financial institution.
There are some pitfalls to avoid with the named beneficiaries on these accounts if the goal is to avoid making the assets available to pay the deceased’s debts. If the named beneficiary passes away before the primary account owner, the asset becomes part of the deceased’s estate. Likewise, naming the estate as beneficiary on one of these accounts makes it part of the estate and therefore available to pay creditors. When it comes to accounts with named beneficiaries, review and update the beneficiary designations regularly.
This article is as information only and should not be considered as tax or legal advice.