When we think about an inheritance, usually we think about money, real estate, and family heirlooms. But what about debt? Can you inherit debt too? If you supported someone through medical school, or if they supported you through the same – everyone is aware of the massive cost and effort. And many have a mountain of debt to show for it early on in their careers. For many clients, one big concern is, “What happens to my debt when I die?” Or on the flip side, “Can I inherit debt?”
Good news and bad news on this one, folks. The short answer: student loans – probably forgivable; other debts – it depends! Just like most other things in financial planning.
The Dreaded Student Loans
For most people, the bulk of their student loans at least started with the federal government. They are fairly easy to qualify for (no credit check!), and the interest rates, while not being the best, are also not the worst. There are also some big advantages to federal loans including potential loan forgiveness if you work in public service for ten years and, apparently, very long periods of loan forbearance during global pandemics (surprise!).
On top of that, federal student loans can be discharged upon death of the borrower. Parent Plus loans will be discharged if either the parent that took the loan out OR the student passes away. One thing you do NOT need to be worried about is your partner or your parents being saddled with your federal student loans if you pass away. This is very straightforward, although someone needs to fill out the paperwork. That’s never straightforward.
Private student loans (whether from when you originally took them out or a refinance) are different. Many of these banks will also offer discharge due to death of the borrower, but it does vary from bank to bank. If you have private loans and are unsure, then reach out to the bank directly to clarify the terms of the loan. If you have a large chunk of loans that will not be discharged upon your death, it will most likely make sense to look into at least enough term life insurance coverage to pay off that debt if needed.
Debts Held Jointly with Another Borrower
Now comes the bad news. Not all debts are like student loans. Any debts that are shared (with the exception of Parent Plus loans mentioned above) become the responsibility of the remaining borrower if one person passes away. For example, if your parents cosigned your first car and something happened to you, they are responsible for both the car and the remaining loan balance. If you own a home jointly with your spouse and are both on the mortgage, your spouse becomes responsible for the mortgage and the house if you pass.
This also applies to debts that are not backed up by an asset like credit cards and personal loans. If you and your partner are both on a credit card and one of you passes, then the other is responsible for that credit card balance. This is way worse, because you don’t generally have an asset to sell to pay off the debt.
Laws also vary state by state, so in some community property states a surviving spouse may need to use any community property to pay debts of their spouse even if they are not personally associated with that debt. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
To get a good sense of your overall family obligations and assets, it is a great idea to periodically take an inventory of your household net worth – everything you own minus everything that you owe. This can also help you assess if you have a need for life insurance as a household.
Your Personal Debt
Now we get into the complicated parts! What happens to debt that you own and no one else? Let’s look at a couple of examples to help tease this one out a bit.
John is single, no kids, and has two surviving parents. If John passes, what happens to the following debts?
- Federal student loans from medical school totaling $275,000 – Discharged by the federal government assuming the appropriate paperwork is filed.
- Credit cards balances in John’s name totaling $20,000 – Become a part of the estate and the estate is responsible for paying them.
- Car loan cosigned with John’s father – John’s father is responsible for the balance of the loan.
In practice, the estate may or may not have enough assets to pay off any debts. For example, if John only had $3,000 to his name, then some of those credit card balances will remain unpaid.
Jane is married (to Alex) with two kids and has two surviving parents as well. She and her spouse DO NOT live in a community property state. She has the following debts when she passes.
- Federal student loans from medical school totaling $275,000 – Discharged by the federal government assuming the appropriate paperwork is filed.
- Credit cards balances in Jane’s name totaling $20,000 – Become a part of the estate and the estate is responsible for paying them.
- A mortgage in Jane’s name only totaling $325,000 – Becomes a part of the estate as does the house.
- Car loan cosigned with Jane’s father – Jane’s father is responsible for the balance of the loan.
In this situation, the debts and assets that are only in Jane’s name become a part of the estate as well. It may seem that Alex therefore is not responsible for those debts, but they are very likely the primary beneficiary of the estate as well. Alex may be able to assume the mortgage and/or refinance the house, but if not, then the house would likely need to be sold to pay off the mortgage and the remaining cash (if any) would go to Alex.
Situations like the one above can make things very complicated when a person passes away. Revisit things like ownership and titling of properties and debts as life evolves and relationships change.
Very slight aside here, life insurance policies and investment account balances will generally be paid directly to the beneficiary listed on those policies and accounts. This is another VERY important thing to consider as life changes. For example, it may be perfectly appropriate to list your parents as beneficiaries on your accounts when you are young and single, but this may not make sense when you are sharing a mortgage with a partner.
As with many other financial planning topics, it can be very helpful to connect with a professional to help you understand the ins and outs of these topics. An estate planning attorney can be especially helpful to understand what happens to your assets and debts when you pass and to make sure things are handled according to your wishes (as much as possible).
Connect with a financial advisor if you are looking to better manage your debt or discuss things like life insurance needs. And as always, you can reach out to all of us here at Finity Group with questions any time.