Are You Going to Saddle Your Kids With Your Debt?

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You want to leave your kids many things: the house, the trust fund, your aunt's tea set. Debt, though, is not one of those things. How can you make sure your personal red ink doesn't spill over into your kids' lives after you die? 

According to the Federal Trade Commission, family members typically are not obligated to dip into their own assets to pay debts of a deceased relative. Family members are also protected by the federal Fair Debt Collection Practices Act (FDCPA), "which prohibits debt collectors from using abusive, unfair, or deceptive practices to try to collect a debt." 

Generally, unless your kids co-signed a loan or some other financial obligation (such as a credit card account) with you, your debts will be paid out of your estate. Though debts get paid before beneficiaries' inheritances, "the estate of the deceased person owes the debt," the FTC website adds. "If there isn't enough money in the estate to cover the debt, it typically goes unpaid. But there are exceptions."

"My impression is that individuals with modest estates, say $500,000 or less, have a poor understanding of what debts will be paid from their estate," says Eve Kaplan of Kaplan Financial Advisors in Berkeley Heights, N.J. "The knowledge level generally increases as potential estates grow, due to the involvement of estate attorneys, elder care attorneys and so on."

To explain the importance of the beneficiary designation to clients, Taylor Schulte, CEO of Define Financial in San Diego, "gently" presents a hypothetical scenario if something happened to clients without appropriate documentation in place. For instance, the default option for some IRA custodian agreements says if an IRA account owner dies without a beneficiary listed on their account, the estate inherits the assets, Schulte says.

"An estate is not a person and therefore doesn't have the same options for how to handle inherited assets," he says. "I remind clients that they have two options: they can choose what happens to their hard-earned money when they're gone, or someone else can. I've never had someone tell me that they are O.K. with someone else choosing how their estate is settled in their absence." 

"It doesn't cost you anything to check your beneficiaries a few times a year," Schulte adds. Kaplan says that such a check becomes critical after such life events as marriage, divorce or the birth of a child.

Debt can be treated differently after death in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) where spouses can share assets and responsibility for debts.

"Many people don't understand how debts are paid after their death," says Raquel Hinman, principal at Hinman Financial Planning in Erie, Colo. "Most parents don't seem too concerned; they have assets that can be sold, such as a home or car, to pay off debts, and there are usually accounts to pay off credit card and other such debt.

"Where I see a little bit more of an issue is with adult children," Hinman says. "One question I ask clients is whether there's anyone they may need to financially support someday. Some mention parents - and they often think that they'll be responsible for the debts of their parents. I counsel them that this isn't true."

And it isn't in Hinman's Colorado. But more than half the nation's states and Puerto Rico have filial responsibility laws or other statues that potentially hold kids legally responsible for their parents' care under some circumstances. Needs-based government programs such as Medicaid have meant that federal law prohibited states from considering the financial responsibility of any person other than a spouse in determining whether an applicant qualifies.

Most filial responsibility states - probably scared of political hot potatoes in their capitals - long ignored these laws. Hinman says she can imagine states trying to enforce such rules more, especially as the population ages and Medicare and Medicaid eat up more funds.

"Many independent and assisted living facilities do a financial review before accepting new residents," she adds. "If they knew that kids could be held responsible for paying accumulated fees, the centers would have little financial risk and little incentive to turn down applicants they might now turn away. Could elderly parents be swayed to pick nicer, and more expensive facilities not realizing they might put a burden on their children?"

"Younger generations ... are going to have enough trouble funding their own retirement without the burden of paying for their parents' debts," Hinman says. "These are [young] people who do not have pensions, fared poorly during the financial crisis, will likely see reduced Social Security and Medicare benefits and generally don't see much in the way of employer contributions toward retirement and benefits. Some children may feel obligated to pay their parents' debts. That's fine as long as it won't put their own future at risk." 

"Clients typically are blissfully ignorant about filial responsibility laws," Kaplan says. "One of my clients was invoiced for bills racked up by his aunt in her nursing home because he was the closest living relative. Given the demographic tsunami of Baby Boomers that will require long-term care, this situation only can become more acute." 

One measure Kaplan takes: discussions with clients about possibly paying for long-term care insurance for their aging parents.

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