For most people, estate planning largely consists of deciding whom they want to receive certain assets when they die. However, most households have complex financial circumstances that typically also include liabilities or debts, not just assets.
Whether you are the executor of an estate or an heir who should receive certain assets from the estate, you may worry about sizable debts left behind by the testator and what implication they may have for everyone else. What debts do people have an obligation to pay when settling an estate?
Certain debts take higher priority than others
Some people think that only specific secured debts require repayment after someone dies, but the truth is that the estate of that person has the same financial obligations that they did in life. In other words, everything from the last hospital bill to credit card debt should wind up repaid in full, if possible, during the administration of an estate.
With bankruptcy, the settling of an estate involves the prioritization of certain debts above others. Specifically, taxes typically get paid first, then secured debts like mortgages, funeral expenses and end-of-life medical costs. Finally, unsecured debts, like certain medical bills and credit card balances, get paid.
Debts can impact what there is to distribute
Some people leave behind more debts than assets. If there aren’t enough assets to repay everything, then the lowest-priority creditors may wind up losing out. They generally can’t take action against anyone else for the estate’s debt.
It is only after the executor takes care of all of those outstanding debts that the estate can begin to distribute the remaining assets among heirs and beneficiaries. In some cases, an executor may need to sell physical assets like art or jewelry in order to repay creditors. Careful accounting is of the utmost importance in estates with significant levels of debt.
What happens if an executor distributes assets without paying off debt?
If an executor mistakenly begins to distribute assets among beneficiaries without repaying all outstanding debts, it is possible for the creditors who do not receive repayment to take legal action against the executor.
Although the executor is not responsible for the debt itself, they had the assets and ability to repay the debt and, in theory, denied the creditor their fair repayment through their actions, thereby putting themselves in a potentially actionable position. Although repaying debts can diminish the value of an estate, it is one of the most important steps in the estate administration process.
