Debt After Death: As a Policy Beneficiary, What Do I Have To Do?

The tragedy of a loved one’s passing brings so many burdens to the surviving family members: grief, fatigue, and financial questions. You have to plan and have a funeral, and then somehow deal with the overwhelming task of notifying creditors of their passing. Then there’s the life insurance. Does it have to pay outstanding debts of the decedent? How does all of this work?

Who Is Responsible For The Debts of the Deceased?

When someone dies, their estate (everything owned at the time of death) may go into probate, during which the will is reviewed and the administration of the estate is handled.¹ The estate is generally responsible to meet the obligations of the deceased. However, other surviving family members may still be fiscally responsible if the deceased had co-signers on any loans or was married in a community property state and has a surviving spouse. Inheritors of estate property, such as a house, car, boat, etc. that are subject to a nonrecourse debt are still required to either pay off any outstanding balance—sometimes by selling the property—or take over remaining payments until the debt has been paid in full.

What is a Beneficiary?

Retirement accounts and life insurance policies generally have someone named to receive or inherit the proceeds in the event of the owner’s death. That person is called the “beneficiary.” Designating a beneficiary for these accounts not only clarifies your asset recipients, but it also makes it easier for them to receive the proceeds and avoid waiting for the probate process to be completed.²

Beneficiaries and Their Responsibilities

Thankfully, if you are named the primary beneficiary—the person to whom the payout normally goes to in the event of the policyholder’s death—that money is yours and is not usually required to cover the insured’s remaining debts. There are exceptions, however.

If your name is listed on any existing debt, perhaps as a cosigner, or you live in a community property state, your current assets (including life insurance inheritance) may be subject to community property rules and taxes at the state level. As of 2018, 9 states impose community property laws: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.³ “Community Property” is defined under the law of each individual state. To determine if life insurance proceeds are included in your state you should seek legal advice specific to the state laws you are subject to.

Additionally, if the estate is paid as the beneficiary, the proceeds from any retirement accounts or life insurance policies would go to the estate itself versus an individual. In that case, the benefits can be used to pay any outstanding debt.² Additionally, a will can give the executor of an estate permission to cover certain obligations with the life insurance proceeds.⁴

Estate Planning

Planning ahead is one of the best choices you can make to protect your loved ones, or help aging parents with estate organization. While life insurance beneficiaries are typically not required to use the money to pay off debts owed by the estate, things such as funeral costs may be their obligation, and not that of the estate. Having a strategy in place can help provide peace of mind for those left behind.

Protection against the unexpected is exactly what life insurance was designed to provide. It is imperative to have the right amount of insurance coverage that is best for you and your family. But just as important is ensuring that the coverage you have and the designations you’ve chosen are the most suitable for any post-mortem debt and tax obligations. By having a plan in place, you can safeguard your family’s legacy and continue to have a positive influence on their futures.