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Will your heirs get slammed with your outstanding debt when you die?

CNBC logo CNBC 9/3/2016 Sarah O'Brien
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Dealing with a loved one's financial struggles can be hard enough when the person is alive. But who's responsible for any debt left behind?

That depends on the particular type of debt, but the answer usually is: Not you.

"I've had clients truly believe they might have to pay their [deceased] parent's debt," said Kathryn Hauer, a certified financial planner with Wilson David Investment Advisors. "But unless you are a co-signor on a loan, you typically are not liable for the debt or have to pay anything out of your pocket."

Comprehensive data on debt held by individuals at death is hard to come by. But according to the Federal Reserve, total U.S. household debt stood at $12.29 trillion in June. And with just 20 percent of Americans carrying no debt, according to a Pew Charitable Trusts 2015 study, it stands to reason that most Americans die owing something (you can download the report here).

But before you delve into the particulars of a loved one's debts, experts say it's important to first understand the legalities of what happens to assets — and liabilities — at death. 

When you die, your assets become your estate, regardless of value. The process of paying off all your debt and then distributing the remaining assets to heirs is called probate.

Each state has its own laws governing how long creditors have to make a claim against the decedent's estate. For instance, it's three months in Indiana and nine months in New Jersey. Other states have additional requirements for both creditors and estate executors, and the process can last a couple years.

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But not all of a person's assets necessarily are counted as part of an estate for probate purposes. For instance, as long as the beneficiary named on any life insurance policies and qualified retirement accounts remains alive, those assets go directly to the beneficiary and are not subject to probate.

Asked if a creditor can reach those protected assets, Gary Altman, founder and principal attorney at Altman & Associates, said, "the answer is generally: Not easily, if at all."

Additionally, debt that was only in the decedent's name is paid by the estate. If a person's liabilities exceed the value of their estate, the creditor typically is out of luck.

However, a handful of states have community property laws, which require a surviving spouse to be responsible for any debt incurred during the marriage, whether the survivor incurred it personally or not.

Remember, too, that when you co-own the debt, it's a different story.

"If you cosign a loan, you are the co-owner," said Hauer at Wilson David Investment Advisors. "If the other person dies, that loan is not forgiven."

One kind of debt that concerns family members, financial advisors say, is of the credit card variety. Federal reserve data shows that Americans carry an aggregate $953.3 billion of such debt.

If your loved one leaves his share of that behind, the card-issuing bank will seek repayment from the estate. Again, if the estate runs dry before the bank is paid, the bank cannot come after family members for repayment.

Even if the account holder allows an authorized user to carry his or her own card, that extra user is not responsible for the credit card debt if the owner dies.

Auto loans are treated the same as credit card debt, although the lender can repossess the car if the estate cannot pay off the loan.

Housing debt — the bulk of Americans' debt at a collective $8.75 trillion — is a bit more complicated upon a homeowner's death. If the mortgage and deed are jointly owned by, say, a husband and wife, there usually is less of a headache.

Cynthia Turoski, a CFP and managing director and owner of The Bonadio Group, had a client whose situation illustrates the snags that can arise if the decedent is the sole homeowner.

The client, a stay-at-home mom with a young child, lost her husband unexpectedly in his late 30s. Because the house and mortgage were in the husband's name only, the lender called the mortgage and sought payment from the estate.

But the estate lacked the funds to pay off the mortgage. Moreover, because the client had no income, she could not qualify for a mortgage on her own.

Luckily, a life insurance policy on the husband covered the mortgage balance so the client and her child could remain in the house.

"At a time when you're grieving, it's unsettling to have to worry about losing your house, too," Turoski said. She added that when there is a joint mortgage and joint ownership of a house, as long as the mortgage continues being paid, the lender usually takes no action on the loan.

Meanwhile, student loan debt, which stands at about $1.3 trillion, also has become an increasing concern at death, as more and more parents cosign their children's student loans.

Federal student loans are forgiven if the student dies. PLUS loans — often held by parents to help pay for education expenses not covered by other forms of financial aid — are forgiven if either the student or the parent dies.

When it comes to private student loans, along with some loans offered through states, it's a different story.

Turoski had a situation where a cosigner of about $150,000 worth of student loans died and the lender threatened to call the loan.

"The issue for the bank was that the cosigner was their security, and now they didn't have that," Turoski explained. The family was able to refinance the loans before the lender acted.

The bottom line is that while your loved one's assets might dwindle as banks and other institutions make claims against the estate, the person's liabilities will not fall to you.

"Technically, your inheritance is decreasing as creditors are paid," said Hauer of Wilson David. "But even if the [estate] is reduced to zero, you are not responsible for any remaining debt."

— By Sarah O'Brien, special to CNBC.com

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