When doing estate planning, a person should give consideration to how future repayment of debts owed to them and also debts owed by them will impact the inheritances to be received by their intended death beneficiaries.
First, debts in a person's estate are payable from the decedent's assets in the course of administering their probate estate or administering their living trust estate. Assets passing directly to a beneficiary without any administration (e.g., life insurance, joint tenancy assets, and Pay on Death ("POD") and Transfer on Death ("TOD") accounts) are not typically subject to repaying a decedent's unsecured debts. Thus, estate planning should consider how a person's debt is repaid. One approach is to purchase life insurance made payable to the trust estate.
Second, a person may specifically gift real property that is subject to repaying an outstanding debt (e.g., a mortgage). Should the beneficiary who receives the residence take it subject to repaying the secured debt or should other assets within the estate repay the debt, and so reduce the balance of the estate for distribution elsewhere. The desired approach should be expressly stated; otherwise, the general (default) rule is that any secured debt goes with the gift. That may or may not be what is intended by the person making the gift.
Third, parents and children may loan money between themselves; typically from parent to child. Such intra (within) family debts merit the parent's attention when doing their estate planning.
Parents may loan money to a child to pay higher education costs, to purchase a house or to start a business. At the parent's death, should any unpaid balance be repaid by the child to the parent's estate or should the child's debt be forgiven? The desired approach should be stated expressly in the will or trust, as relevant
If the parent wants the unpaid balance to be repaid, then the debt obligation (e.g., promissory note) and its payment history (ledger) both need to be in writing and be kept up to date. The debt can be assigned to the parent(s)' trust and be enforced by the successor trustee (during the parent's incapacity or at death).
At death, the unpaid balance would need to be added back into the value of the trust estate in order to arrive at the gross value of the estate needed to compute each share of the total estate (i.e., including the unpaid debt). Typically, the unpaid balance is then subtracted from the debtor's share as an advance.
Children may also be owed money from a parent, e.g., the child provides a parent with at home personal care services or lends money to cover a parent's costs of living. If so, the debt and its repayment history should be in writing and kept up to date.
Also, it may help if the parent's living trust acknowledges the parent's debt to the child and that the debt will be paid from the proceeds of the parent's estate (e.g., sale of home) prior to the division of the parent's remaining estate amongst the parent's death beneficiaries.
The foregoing is a brief discussion of some issues to be considered where debts impact a person's estate planning. For legal guidance consult a qualified attorney.
Dennis A. Fordham, attorney, is a State Bar-Certified Specialist in estate planning, probate and trust law. His office is at 870 S. Main St., Lakeport, Calif. He can be reached at Dennis@DennisFordhamLaw.com and 707-263-3235.
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