THE BLOG
09/03/2014 11:45 am ET Updated Nov 03, 2014

Will Your Kids Inherit Your Debt?

Many people finally get around to writing a will in order to safeguard their assets for their heirs. But what if you've got the opposite problem: Your nest egg was decimated by the recession, bad investments or simply living longer than expected and now you've got a mountain of bills you can't pay off.

Will your kids inherit your debts after you die?

The short answer is, not in most cases. But there are situations where someone could be legally responsible for paying off your bills after death. Plus, aggressive creditors have been known to coerce heirs into paying off debts for which they're not responsible, just to be left alone.

If you're afraid that your financial legacy will be a heap of unpaid bills, here's what you need to know and prepare for:

Unsecured debts. In general, children aren't responsible for paying off their parents' unsecured debts -- things like credit cards, personal loans and medical bills, which aren't collateralized by physical property. If there's not enough money in the estate to pay off those bills, creditors will have to write them off.

There are several exceptions, however:
  • If your child, spouse or other acquaintance is a cosigner on a credit card or loan (including a mortgage, car or personal loan), they share equal responsibility for paying it off. This is why you should always think twice before cosigning anyone's loan.
  • If someone is a joint account holder -- that is, their income and credit history were used to help obtain the loan or credit card -- they're generally responsible to pay off the balance.
  • Widows and widowers are responsible for their deceased spouse's debts if they live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin; and Alaska, if the couple opts in).
  • If you have power of attorney or a conservatorship for someone and misspend his or her money, you could be held accountable.

Note that authorized users on your credit cards aren't liable for repayment since they didn't originally apply for the credit. Chances are they were simply "piggybacking" on your credit record to help build their own. However, to protect authorized users from being bothered by creditors after your death, you may want to remove them from your accounts -- especially if they now can qualify for credit on their own.

Secured debts. If you have outstanding secured debts upon death, such as a mortgage or car loan, your estate must pay them off or the creditor can seize the underlying asset. For example, if you were planning to leave your house to your kids, they'll need to either pay off or continue making payments on any outstanding mortgage, property taxes and insurance, or risk foreclosure.

Exempt assets. Depending on your state's laws, there are a few types of assets you can pass along to beneficiaries that generally won't be subject to probate or taxation and thus may be safe from creditors. The most common are life insurance proceeds and retirement benefits like IRAs and 401(k) plans.

Just be aware that if you name your estate as beneficiary for an insurance policy or retirement account, creditors can come after the money to pay off your debts. Thus, it's usually wise to name specific individuals as beneficiaries -- and back-up beneficiaries, in case they die first. Also, if your beneficiary is a cosigner on any of your debts, creditors can pursue him or her for any balances owed.

A few other thoughts:
  • If you're an heir who's not responsible for someone's debts after death and creditors contact you for payment, refer them to the estate's executor, who is charged with notifying all creditors, the three major credit bureaus and government agencies (like Social Security, Medicare and the DMV) about the person's death.
  • If you're an authorized user on a credit card account, don't use the card after the main cardholder dies -- that's fraud. Surviving spouses or other cosigners should ask for a new account to be opened in their own name.
  • If your parents leave you a home that's "underwater" (the outstanding mortgage is more than the property is worth) and you can't afford the loan, it may make sense to refuse the inheritance. Likewise with an under-valued timeshare property you have no intention of using.
  • For parents who still owe money on federal PLUS loans for their child's education, the debt is usually dismissed if they or the child die. However, private parental education loans often are not forgiven at death and lenders may go after the estate for recovery.
Check with a probate attorney or legal clinic familiar with your state's inheritance and tax laws. Free or low-cost legal assistance is often available for lower-income people. A few helpful sites include LawHelp.org, Legal Services Corporation and the American Bar Association.

Bottom line: If you expect to leave unpaid debts after you die, alert your family now, so that together you can plan a course of action. You don't want to blindside your loved ones in the midst of their grief.

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.

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