What Happens to Your Debt When You Pass Away

By John C. Martin, Contributor

What happens to a person’s debts after death? Every state handles this issue a bit differently. This article discusses how debts are handled in California in the following situations: 

  • Debts when a probate is required
  • Debts when assets are held in a revocable living trust
  • Situations when someone can become responsible for debts after your death
  • How you can get your finances in order before you die so your family isn’t placed in a difficult situation

In California, most debts are handled in a probate proceeding. A probate proceeding is a legal action for the administration of a decedent’s estate. When a probate is initiated, known creditors of a decedent must be contacted directly by the executor. A notice to creditors must also be published in a newspaper of general circulation. Creditors then have four months after letters are issued to the executor to file their claims. If notice requirements are followed and creditors do not file their claims within the four month period, then these debts may be time-barred. Validly filed claims may be accepted or rejected by the personal representative for the estate. The debts are paid out of the decedent’s estate prior to distribution under the decedent’s will or the laws of intestate succession.

When no probate is required, there is no statutory duty to contact creditors directly or to file a notice to creditors in a court of general circulation. This is the case when individuals fund assets, which otherwise would have been subject to probate, into a revocable living trust. In such a case, the creditor must take action themselves to either file a probate, or sue the trustee of the revocable living trust directly. In all cases in California, there is a one-year statute of limitations for claims against a decedent’s estate. Accordingly, claims that are not filed by creditors against a decedent’s estate are generally time-barred and cannot be collected.

In general, all debts of a decedent will be paid at the time of probate or trust administration before the distribution to beneficiaries. The executor or trustee will be responsible for payment of debt, and not the individual beneficiaries. However, there is an exception when an asset is left to a beneficiary subject to indebtedness. At the same time, the beneficiary could always disclaim the gift, in which case it would pass to the other beneficiaries under the decedent’s estate plan, or ultimately escheat to the state.

Note that in the case of real estate subject to indebtedness which passes to a spouse or child, Federal law (Garn-St. Germain Depository Institutions Act of 1982) provides that a “due on sale” clause under a deed of trust will not be triggered. As such, real estate can be left to a spouse or children subject to the terms of an existing loan.

We recommend that individuals execute comprehensive estate plans which address the payment of debts. By transferring assets into a revocable living trust, clients in California will avoid unnecessary intrusion into their private lives by the state. Notice and publication requirements do not exist if a probate is never initiated in California. As a result, a living trust results in substantial privacy and debt collection benefits versus a will alone. Individuals should also consider purchasing life insurance in order to address the payment of debts in the event of death.

Have more questions? Visit our website at johncmartinlaw.com. John C. Martin is a certified specialist in Estate Planning, Trust, and Probate Law. This article is current as of the date it was written. Laws change over time and this article may become outdated. Do not communicate confidential information by email. This article does not create an attorney-client relationship.

Source: EZine

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