You can inherit debt, although it is rare. Before you sigh with relief, make sure you understand what kind of debt can be passed along to you. It’s both a myth that you cannot inherit debt and a myth that you can. That’s because the reality is far more complex and nuanced in real life.
Inheriting debts is not something anyone wants to face, but it’s a situation that many people come face-to-face with after someone in their family passes away. Keep reading for an outline that shows which debts can be inherited as well as a rundown of protected asset classes so you can build a stronger financial plan.
How debt gets passed down
While you can’t inherit most forms of debt, the deceased person’s debts will likely be subtracted from their estate, which ultimately reduces the amount of inheritance that is available. For example, if a person dies with $40,000 in debt and an estate valued at $800,000, the beneficiaries of the estate would receive $760,000 before taxes are deducted.
If the estate doesn’t have enough funds to pay for the remaining debt, the debts might not be paid and creditors could end up dismissing what is owed. In some cases, you’ll be held liable for the debt.
How to manage debt after death
Inheriting debts is not something anyone wants to think about when they are grieving, but when you lose a loved one who left a lot of debts behind, debt collectors might come calling. If you find debt collectors at your door, they might even be trying to collect a debt that is either no longer applicable or that has passed the statute of limitations.
In addition to trying to manage your grief, you may not have a full picture of your loved one’s finances and what they were liable for prior to passing away. Likewise, you might not have any clue what you are now liable for either, which is why it can help to hire a lawyer.
Also, when you’re left wondering if you inherit your parents’ debt now or not, remember that the estate will handle debt in many cases. Don’t jump to conclusions or worry about responding to a debt collector at the door. Leave everything up to the estate lawyers you have hired to manage the estate.
How to manage debt collectors after death
Is debt inheritable? It can be, but don’t act on any debts just yet. Remember that just because a debt collector comes calling doesn’t mean you have to pay right away or even at all.
Debt collection agencies are allowed to contact the executor of an estate or a surviving spouse, at which point they may request payment. However, they aren’t allowed to claim that the debt is owed by the beneficiaries nor the surviving family members.
Collection agencies must clearly state that the surviving family members are not obligated to pay the debt, but you shouldn’t necessarily believe everything a debt collector says, especially about inheriting debts. They may be pressing you to acknowledge the debt as a way of extending the statute of limitations on old debt.
If a debt collector contacts you, take whatever information they are offering and present them with a copy of the death certificate. Do not acknowledge the debt, offer payment plans or make promises about anything. You can simply state that the person in question is deceased and that you are unaware of any debt in their name.
You can also ask if the debt is time-barred. Creditors are legally required to disclose if a debt is time-barred as well as the name under whom the debt is listed. This will help you decide if any further steps are required regarding the process of inheriting debts.
Debts that can be inherited
Generally speaking, family members won’t be required to use their own money to pay for a deceased relative’s debt. Many debts cannot be inherited, but some debt can be passed along to other family members.
These types of debt are usually those of a surviving spouse, a co-signer on the debt or in the form of mortgages. Here’s how inheriting debts could affect you.
Joint and cosigned debt
If you are the cosigner on debt or the debt is jointly held, you will be liable for the full value of the debt in the event that your partner passes away. This includes credit card debt, mortgages, business loans, personal loans and a number of other debts. In general, an authorized user on a credit card or bank account will not usually be responsible for the debt.
In some states, debt can be passed along to the surviving spouse. Known as community property states, states in which debt is often passed along to the surviving spouse include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
In community property states, the surviving spouse may be required to pay the deceased spouse’s debts. In Alaska, spouses have the option to make their property communal, including debts and assets, when they get married, though most people do not do this.
Mortgage or home equity loan
Inheriting a house means inheriting debts if the home isn’t owned outright. As such, you’ll be responsible for the debts on that property. This means you will be responsible for the continued mortgage payments if you don’t otherwise have to pay the debt in full.
Assets that are protected from creditors
If you’ve recently received an inheritance and you are afraid that creditors will come after you, remember that these are protected assets. More specifically, protected assets include retirement accounts, trusts and life insurance.
Trusts are the most favorable way of passing on generational wealth in part because they are categorized as protected asset classes. Also called non-probate assets, you can bypass probate court and receive the assets from protected asset classes directly, regardless of whether or not there is a will. This can prevent beneficiaries from inheriting debts.
Retirement accounts include 401(k)s, IRAs, Roth IRAs and any other retirement accounts that list you as a beneficiary. The funds within these accounts should go directly to you, not to creditors.
The named beneficiary of a life insurance policy will receive life insurance directly. It cannot be taken by creditors.
Trusts hold assets for beneficiaries, and they usually bypass probate processes. In addition to being protected from creditor claims, certain types of trusts can reduce the tax burden that beneficiaries have to face, further protecting the value of their inheritance.
Not all debt will be inherited
Can you inherit debt? Yes, it’s possible, but it is not guaranteed. Generally speaking, all debt will be deducted from the estate before you receive an inheritance.
Certain asset classes are protected and they will be passed along to you directly. On the other hand, you will likely inherit debt if you are a cosigner on the debt or the surviving spouse in a common property state.
Do you inherit your parents’ debt? Yes, you may inherit it directly or have it deducted from the estate. But again, the outcome depends on what is set up prior to their death.
It’s a good idea to work with your spouse and your family members to set up a financial structure that will protect you and your family in case the worst happens. Retirement accounts, trusts and life insurance are all ways by which your family can ensure they are protected now and in the future.
Can the IRS come after me for my parents’ debt?
Yes, if your parents died with money owed to the government, you could be responsible for that debt. Officially, surviving children or the spouse of the deceased person need to file their final tax return and pay any tax liabilities that are theirs to pay.
Do I have to pay my deceased husband’s credit card debt?
Whether or not you will inherit certain debts will depend on your state of residence. In community property states, you will be responsible for your deceased husband’s credit card debt. In other states, it may be paid for by their estate instead.
Can creditors come after your inheritance?
Yes, creditors can come after your inheritance, although whether they have legal rights to do so or not will depend on the estate of the deceased person, your relationship with them and the state in which you reside. While the estate is generally responsible for all debts, this can be officially settled in probate court.
Do children inherit debt?
In most cases, children are not responsible for their deceased parents’ debts. Debts on the estate will be settled during the probate process.