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When you’re deciding how to divide your assets among multiple heirs, it’s very important to consider who will pay your estate’s debts out of their share. Two bequests that look equal in theory might be very different in practice once debts are taken into account.
Generally, when a person dies, his or her outstanding debts must be paid out of “probate assets.” This means the assets that pass to someone according to the person’s will. But many assets don’t pass via a will. For instance, a jointly held bank account, jointly owned real estate, an IRA, a 401(k), and a “transfer on death” brokerage account might all pass to someone outside of a will, and thus not count as probate assets.
Also, life insurance proceeds aren’t dependent on a will and aren’t considered probate assets either.
That means that if you have three children, and one gets your retirement accounts, one gets your life insurance proceeds, and the third gets everything else, the third child will be saddled with paying 100% of your debts.
What’s a debt? Debts can include taxes, a mortgage, outstanding credit card bills, personal loans, condo fees, and more. Even car leases can cause problems, because some contracts treat a person’s death as an “early termination” of the lease.
Of course, your children or other heirs might be very cooperative and agree to share the burden of your debts. But it’s usually much easier for everyone if you take debts into account in your estate planning, and divide your assets accordingly.