Avoid Inheriting the Debts of Your Closest Relatives

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As a life insurance agent, I hear from a lot of people who try to take advantage of their connection to a family member by purchasing a life insurance policy on them.

I remember a woman looking to purchase $1 million of coverage on her mother. Upon questioning, I discovered her mother was in hospice care with no more than one or two days to live. It was clear that she was simply looking to profit from her mother's death.

While the intentions of this daughter may be in question, many people ask me about insuring their parents, children or siblings to avoid getting saddled with their loved ones' debts. Even thought many unscrupulous agents will be happy to sell you a policy, that's not necessarily a valid concern.

Very Few Get Stuck with Their Parents' or Children's Debt

Generally speaking, the only debt you need to worry about is that of your spouse. As for the debts of your parents, children, siblings, aunts, uncles, cousins, next of kin, etc., you typically need not worry about it coming back to you.

Let's say your parents were to pass away with $10,000 in a bank savings account and $6,000 in credit debt. Their estate would first gather up any assets they had (such as the $10,000 in the bank) and would be obligated to pay the debt out of those assets. After all debts are settled, any remaining assets can then be distributed to their heirs.

However, if your parents had no assets available to pay the debt, it does not transfer to you. As Rebecca Lack, a San Diego attorney from Lack Law Group, explained:

"If a loved one dies, only that person's estate is responsible for the debts of the decedent. Debts do not transfer to spouses, parents or kids, but whatever assets the decedent leaves behind will be used to pay the debts of that person."

Important Exceptions

There are a few exceptions. The first is if you are a co-borrower or guarantor on a debt with your loved one. One common example is parents who co-sign for their children's student loans. In the event of that child's death, the parents would become responsible for the balance, like these parents who are now responsible for their daughter's $100,000 student loan debt after she died in a tragic accident.

Another exception is spousal debt -- in some states.
  • Community property states. There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin, plus the territory of Puerto Rico. Alaska also allows married couples the choice of opting in to community-property status. If you live in these states (although laws vary slightly), your finances automatically become entwined as soon as you marry. In these cases, you will become responsible for the debts of your spouse when they die, even if you were not named as a co-borrower or joint account owner on your spouse's debt. You are not, however, responsible for debts that they incur before the marriage. The only way you may be able to avoid your spouse's debts in these states is if you sign an agreement with your spouse to specify that their individual debts are not your responsibility.
  • Common law states. If you are married and live in a common law state, you are not responsible for the individual debts of your spouse unless it is a debt which you have both signed. This also includes joint accounts, joint credit cards or if you are a co-signer or guarantor on any loans.
Caution: Lack of Legal Responsibility May Not Deter the Creditors

Don't assume just because you're not responsible to pay for your loved one's debts that their creditors will tell you the same thing because they will call.

Chris Huntley, director of marketing at JRC Insurance Group, recounted the how he was hassled by creditors after his father's passing.

"After my dad passed, mostly I just received calls or letters from his creditors wanting to know if he had an estate. But one of his credit card companies called me and told me that I had to pay this off right now. I told him that he should be talking to the estate representative and provided the contact information. I told him he should know better and not bother me again. He knew he was in the wrong and didn't call back."

It's a frequent practice of creditors or their agents to contact a surviving family member to collect money on outstanding debts. The best thing to do is to advise them of the name of the executor if they have a will. If the deceased didn't have a will, a probate court would appoint an administrator, personal representative or universal successor, and that's the person the creditor needs to contact.

Creditors and their representatives cannot repeatedly call you or harass you to collect on the debts of family members, the Fair Debt Collection Protection Act says. You may have to send the creditor a certified letter to advise the creditor to cease calling you. You can even do this if you are the executor of the will.

However, creditors can call you once only to ask you for contact information on the executor or administrator -- but don't give them any other personal or financial information about the deceased.

A Vital Life Insurance Loophole You Should Know About

If all debts must be paid first to creditors before assets can be distributed to the beneficiaries, it stands to reason that someone with few assets and a lot of debt wouldn't be able to leave his or her family with an inheritance, right? There is a way around that.

Life insurance bypasses probate because life insurance death benefits proceeds are paid directly to the named beneficiary(ies). It's generally not considered part of the estate, so creditors and their representatives cannot lay claim to this money.

And beneficiaries of life insurance benefits are not obligated to use any of this money to cover the outstanding debts of family members, unless they are also financially and therefore legally bound to the debt.

When You Need to Buy Life Insurance to Cover a Family Member's Debts

You should only have to buy life insurance to cover the debts of other members of your family in the following situations:
  • Co-sign or be a guarantor of a loan. Any loan that you co-sign with another family member or are a guarantor should also be covered with at least an equivalent amount of life insurance because you will be liable for the outstanding balance should that person die before the loan is paid.
  • Live in a community property state. If you live in a community property state, you and your spouse should discuss your joint debts and should consider buying life insurance to ensure the debts are covered by life insurance.
  • Have joint accounts or debts. If you are married and have a joint account, creditors can attach this account to cover all the outstanding debts on your spouse. Similarly, any debts that you have signed together then you, as the surviving spouse, will be responsible to pay off the debts regardless of where you live, and it would be very prudent to have a life insurance policy to cover these situations.
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