No one likes to think about death, but it’s something that’ll come knocking on the door sooner or later. Your death will cause emotional turmoil for your loved ones, and you owe it to them to help make the transition easier. That’s why estate planning is important.
Estate planning allows you to decide exactly who will benefit from your estate and to what extent. And if you truly want your wishes to be fulfilled, you must factor in your debts during this process. In this post, we explore what happens to your debts when you die and how to better handle them with estate planning.
Handling Bills During Probate
Probate refers to the general administering of a deceased person’s will or the estate of a deceased person without a will. But the debt you leave behind and how well you protect your assets will determine how much your beneficiaries get.
- Personal Debt
When you die, personal debts cannot be passed on to surviving family members. Good news, right? But hang on a minute: this doesn’t mean your debt disappears. Instead, your estate becomes responsible for paying your debts, such as credit card balance, outstanding loans, etc. In simple terms, what this means is that your assets are liquidated to pay your debts.
Shared debts are a notable exemption to the impact of personal debts. For instance, if you live in a community property state and one partner dies, the other partner is still legally liable for paying the balance. In contrast, in common state laws, the partner whose name is on the loan or deed is fully responsible for the loan.
When personal assets are sold to clear off your debt, then the remaining is disbursed to your beneficiaries. In an event where your asset is unable to cover all of your debts, your family would not be responsible for it. The debt will simply go unpaid.
- Business Debt
Business debts are treated based on the status of the business. Without proper planning, the business debts of a sole proprietor will be treated as personal debt and the owner’s estate will be used to pay them off.
Limited liability companies or corporations, on the other hand, are distinct entities separate from the founder. Only assets of the business can be used to satisfy the claims of creditors should an LLC member die.
How Estate Planning Can Help Protect Your Estate
For starters, a will and a living trust allow you to define beneficiaries of your assets. A trust can help you avoid probate, reduce settlement costs, and protect your privacy. On the other hand, a will incurs probate fees, just as it is a public document.
A will or trust is not a full-proof mechanism to protect your assets from liquidation to clear your debt, but it offers limited protection. Some of which include.
- Defining priorities of beneficiaries.
With a will or trust, you can define beneficiaries that you want to be settled no matter what. In this case, they are first settled after your debts have been resolved. For instance, if you want your brother to receive one of your vintage cars without transferring the auto loan burden on him, you can specify that in your will. This way, other assets can be sold to settle your auto debt so your brother can receive your car without the burden of debt.
- Defining gifts based on percentages
If you have large amounts of debts, then it’s likely that lots of your assets will be liquidated. If that’s the case, directly assigning assets to beneficiaries isn’t ideal as many of these assets will be sold to clear off your debt. By defining your gifts to beneficiaries as a percentage, the amount that is remaining after your debts have been cleared can be distributed to them according to your wishes.
Keeping Your Assets Out of Creditor’s Reach
As noted earlier, a will or trust will simplify and clarify the disbursement of your assets when you die, but it doesn’t stop creditors from claiming your assets. The key to keeping your asset out of reach is to ensure they are not included in your estate. Luckily, there are several ways to accomplish that, including:
- Beneficiary Designations
Designating a beneficiary on your brokerage accounts, IRAs, retirement plans, life insurance policies, 401k plans, pensions, and other accounts will transfer the benefits to your beneficiary’s estate instead of yours. That way, they cannot be used to pay off your debt.
Ensure that you include an alternate beneficiary in addition to your primary beneficiary. Also, ensure that you review and update your beneficiaries as needed, so you don’t have your funds going to someone you don’t want to receive your gift – like a former spouse.
- Life Insurance
Purchasing life insurance is also a great way to ensure that funds go directly to your beneficiaries when you die. Only your loved ones are entitled to the cash, and most life insurance companies typically process claims quickly.
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