For many parents, the last thing they want is to leave their children debts after they are gone. However, this is becoming more and more common. The Federal Reserve's Survey on Consumer Finances showed that for families headed by seniors age 65 to 74, those that had debt rose from 50% in 1989 to 66% in 2013. Not only that, during the same period of time, the debt load doubled.
Some of the main reasons for this trend is the rising cost of healthcare, people living longer, and the reality that about 40% of your lifetime expenditure on healthcare occurs after age 70. For those seniors who don't have a Long Term Care policy or adequate healthcare protection, those costs are paid from credit cards, or from refinancing their homes.
It's not uncommon for surviving children to discover that their parents left dozens of credit cards with overdue payments, and large mortgage balances. What happens to unpaid bills when you die? What debts are passed onto the next generation? Here are some answers to these questions.
What happens to unpaid debts after you die?
Typically, when a person passes away, the person's estate owes the debt. If there is not enough in the estate to pay the debt, the debt goes unpaid.
What happens to credit card debt?
Children are usually not responsible for any remaining credit card debt that their parents owed, no matter what the reason is for the debt. However, a child who is a co-owner of the credit card would still be liable for the debt.
What about loans that were taken out by parents for the children's education?
For a parent's federal student loan, or Parent Plus loan, any balance remaining at their death is taken off the books. However, according to the Education Department, their estate could be required to pay taxes on the forgiven loan.
How do I protect retirement assets from creditors?
Many attorneys will advise their clients not to name their living trust as the beneficiary of their retirement accounts, such as Individual Retirement Accounts, 401(k)s, 403(b)s and 457 deferred compensation accounts. What can happen is that the Internal Revenue Service would tax these accounts, and only the net amount after taxes would be distributed to family members.
It's often better to name real people (like children or grandchildren) as beneficiaries of retirement accounts rather than the trust. This way, the children can create Inherited IRAs after the parents have passed away, the money can be transferred from the parents' IRAs to the children's IRAs tax-free, and the money is able to grow tax-deferred for another life expectancy. Even a modest IRA, when it benefits from 2 generations of tax-deferred growth, can balloon to an impressive value. The owner of the Inherited IRA has to take a Required Minimum Distribution each year, but it's age-weighted and can be quite small.
Similarly, if the living trust is named as the beneficiary of a retirement account, existing creditors can attach the estate even before it gets to the children. However, a retirement plan that has real people as beneficiaries cannot be touched by the creditors of the deceased.
Consult with an attorney that specializes in wills, trusts, or estate planning if your parents passed away with significant debt. He or she can give you advice for your specific circumstances and goals.
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