How to Handle Debts in an Estate
Your Guide to Understanding How Estate Assets are Used to Pay Valid Claims
The passing of a family member is always a painful time. Sometimes, however, the pain can be compounded by financial stress. This is especially true if your loved one died with outstanding debts that must now be paid. A complex process exists for handling debts of a decedent in estates, and it requires careful planning that we’ll discuss below.
Estate Basics
When it comes to handling claims against an estate under U.S. law, things are fairly simple if the estate is solvent, though laws vary by state. When an estate is not solvent, however, things can get complicated quickly.
The executor of the estate, also called a personal representative, has a legal duty to marshal the assets and the debts of the estate. This involves three steps:
- Making an inventory of the decedent’s debts
- Determining the validity of said debts
- Paying valid debts
When it comes to determining validity, it’s generally easy if you’re talking about services your family member contracted for or goods they purchased. Some debts can be less clear-cut, though, like those based on verbal agreements for which no written contract exists.
When an estate is not solvent, meaning there are not enough assets to pay all valid debts, statutorily preferred claims get paid first. Administrative Expenses will be paid as first priority. This refers to the costs and expenses related to the administration of the estate, like legal and accounting fees, and the costs of securing and appraising the estate’s assets.
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After Administrative Expenses, the order of payment proceeds in this way:
- · Reasonable Funeral Expenses
- · Debts or Taxes with Federal Law Preference
- · Necessary Medical Bills of the Last Illness the Deceased Suffered
- · Debts and Taxes with State Law preference
- · Reimbursements of payments of benefits (i.e. Medicaid)
- · All other claims not covered above
How Payment Occurs
The estate’s assets are used to pay each debt in reverse asset priority. Any assets passing by intestacy are applied first. If a will exists, then debts will be paid first from any assets falling under the residuary clause of the will, followed by those falling under general gift in the will and then specific gift assets.
Here’s an example scenario:
Let’s say your loved one’s will reads, “I leave my coin collection to my niece, then I give $50,000 each to my nieces and nephews, and I give the remainder of my estate to my siblings.” When valid debts are outstanding, it’s the “remainder of the estate” assets that are used for payment first, then moving to the $50,000 designated for each niece and nephew, then finally the proceeds from selling the coin collection.
Secured and Unsecured Debts
Secured debts are things like mortgages and auto loans – they are backed by collateral. The bank or other creditor can foreclose on the loan and force the asset's sale to satisfy the debt. An executor can – but isn’t required to – pay off secured debts in the estate. The exception is when the proceeds of such a sale would not cover all of the secured debt.
Unsecured debts are those not backed by any sort of collateral. This can include things like credit card debt, medical bills, and utility bills. They must also be paid, so long as there are sufficient funds in the estate. If there are not, unsecured debts may go unpaid.
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Other Claims Against an Estate
Aside from the types of claims mentioned above, there may be other types of claims on an estate, too. One typical example is the statutory rights of a surviving spouse or minor children, which must be balanced against the claims of all the types of creditors mentioned above.
Non-probate assets, including things like assets in an irrevocable trust with an asset protection clause, are not subject to the claims of creditors. There are also specified processes that a creditor must undertake in order to make a claim on an estate. The procedures vary state by state, and they are specific to the degree that, if the proper procedure is not followed, the creditor’s claim will be disallowed – even if it represents a valid debt. Foremost among these procedures is that creditors wishing to make a claim for an unsecured debt must do so within one year of the decedent’s date of death. In the U.S., a notice of the administration of the estate must be published, and this is considered to serve as a public notice to creditors.
Strategies for Protecting Assets
As alluded to above in the discussion of non-probate assets with protection clauses, there are ways to protect assets in an estate from the claims of creditors. The purchase of life insurance, for example, is a common way to shift the risk of unexpected death when a person has significant debts but wants to protect their assets for designated heirs.
If you’re interested in having a discussion about how to protect your assets from potential debts, it’s useful to speak with an estate planning professional. At Echo Wealth Management, we provide our clients with financial plans that encompass the expertise of wealth managers, accountants, and estate attorneys. We take pride in helping you accomplish your financial and life goals, so please reach out today to begin a conversation about your estate plan and more. We look forward to speaking with you!
