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Beneficiary vs. Creditor: Who Wins?

Beneficiary vs. Creditor: Who Wins?

Most people die with some form of debt, be it credit cards, student loans, mortgages and lines of credit. While some people die with an insolvent estate, meaning that their debts far outweigh their assets, what happens if mom dies with a Will stipulating her assets are to be equally split amongst her children, yet has an outstanding creditor? Who wins?

The job of figuring this out falls to the Executor, or Administrator if the decedent died without a will. The executor has the obligation to address any filed creditor claim. However, a creditor does not have an indefinite period of time to file a claim. They have one year from the date the Executor or Administrator is sworn in at the Register of Wills to file their claim or else the claim is forever barred. Payment of a debt is not automatic – if owed money, the creditor better file the claim sooner than later.

Executors should not go this road alone. All fiduciaries should hire an experienced estate attorney if for no other reason than to guarantee that the steps are properly taken to remove any future liability from their own shoulders. Attorney fees may be costly but the estate pays for them along with any inheritance tax, filing fee, creditor claim, etc. To wade the probate river without guidance is a foolish endeavor especially since the chance of personal liability is real.

Beneficiaries have the right to request that the Executor provide detailed description of what he/she did with the assets managed and justify any expenses paid. There are two types of accountings: informal and formal.

An informal accounting is when the Executor provides the information only to the parties of interest without the court’s involvement. This is dependent on what the interested parties request – bank statements or detailed reports. A formal accounting is very specific based on detailed specifications in which the court has already approved. Not only do the parties of interest receive a copy but so does the Court in order to approve and prepare for at least one court hearing.

Upon approval, the creditors of the estate are paid; if not in full, in proportion to the debt to asset ratio. However, these are not the first debts paid. When a decedent dies, their property is used to pay for probate and funeral expenses. Then debts are paid prior to any disbursements to beneficiaries. Each creditor is different – some creditors are willing to negotiate or allow a beneficiary to assume the debt or take the property subject to the debt.

If the debts exceed the assets, the beneficiaries do not inherit the decedent’s debt. The same holds true that if a credit card is solely in the decedent’s name, no one can use the credit card after the decedent’s death. The amount owed is an estate debt but the card should not be used by a beneficiary or Executor of the decedent’s estate after the decedent’s death.

We are often asked how to avoid the probate process and the only answer is by using either a revocable living trust or taking advantage of listing beneficiaries on those assets with beneficiary designations. Otherwise, if you pass away with an asset in your individual name, probate must occur in the state that the asset is held. Meaning if you individually own a house in Pennsylvania and North Carolina, your Executor will have to probate your estate in both states.

There is a huge difference between having an asset funded into a trust rather than slapping on one of your kid’s names as a joint owner of an asset. Do not sacrifice asset protection to save probate costs. Contact us to discuss your options and what makes the most sense for your family.