Whether or not you believe in the afterlife, there’s one thing that can’t be disputed: debt after death lives on. Seventy-three percent of Americans die with some form of debt to their name, with an average debt of $61,554, including home loans, according to Credit.com.
While the deceased might escape the creditors, their survivors don’t. This can be a source of stress for survivors, but contrary to popular belief, family members are not responsible for paying outstanding debt in most cases. The exceptions are community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin, and Alaska) where a spouse can be held responsible for the debts of another.
Regardless of domicile, any amount owed to creditors needs to be settled by the deceased’s estate during probate. Debt does not extend beyond the estate, however. If the estate does not hold enough assets to satisfy creditors, the debt ends.
The estate’s responsibility for debt after death means beneficiaries might not receive the full amount intended and could miss out on expected distributions. As an estate planning attorney, you can help protect your client’s beneficiaries. Here’s how.
Take out a life insurance policy
Every estate plan should include a life insurance policy. Why? Not all of the deceased’s assets go through the probate process. Insurance, IRA and 401(k) proceeds are not commonly considered assets of an estate and are distributed to beneficiaries regardless of debt.
Insurance proceeds can end up in probate if the named beneficiaries are deceased or none are named. In that event, the insurance company issues a check for the policy to the probate court, which then deducts fees and distributes the remaining amount according to the deceased’s will.
Set up an irrevocable trust
If your client is intent on protecting his or her assets from creditors, advise them to set up an irrevocable trust. Once an irrevocable trust is created, the creator no longer legally owns the assets used to fund it and can no longer control how the assets are distributed. Additionally, any subsequent changes to the trust must be approved by the beneficiary. Therefore, creditors cannot satisfy any debts from assets in the trust.
However, a court can rule that an asset transfer was conducted in an attempt to defraud creditors. Therefore, it’s important to make plans well before your client anticipates any debt liability to avoid legal intervention.
Use a qualified disclaimer
A qualified disclaimer is a refusal to accept property or assets bequeathed in a will or similar document. When the beneficiary of an estate or trust submits a qualified disclaimer, the IRS permits the property to skip to the next person in line. For tax purposes, it is as though the beneficiary never receives any interest in the property.
Several scenarios exist where this strategy can be beneficial. For instance, the beneficiary might not want to inherit money because of outstanding debt or other circumstances that would transfer assets to creditors.
WealthCounsel’s estate planning software can streamline the creation of irrevocable life insurance forms and trusts, and help protect your client’s assets from creditors. Download our irrevocable living trust sample to see how your practice can automate document creation with Wealth Docx.
