Trustors usually develop thorough plans for distribution of their estate assets, applying careful thought about who-gets-what. However, it is common for less analysis to be done in planning for how to handle outstanding debts and who is responsible for the payments. Here are some thoughts to discuss with your estate planning attorney:
Payments for Liabilities
As a trustor, it is helpful to update your balance sheet on a regular basis. Making a comprehensive list will streamline the process of handling debts after a loved one has passed. It also helps in distribution planning.
After passing of the decedent, key responsibilities of a trustee include preparing a summary of all assets and liabilities of the estate, collecting all notices of debt, and then paying debt obligations on a timely basis. Although it is not required by state law for living trusts, it should be done and is probably the most important step in the trust settlement process (note: a formal inventory and appraisement is required by law for probate estates). No debt, liability or claim should be paid until you meet with an estate attorney. If the estate debts are not paid in the proper order, the trustee could have personal liability.
Liabilities are all financial obligations of the estate, which include funeral expenses and medical bills for the decedent, mortgages, vehicle loans, other outstanding loans and lines of credit, taxes, insurance, utility bills, storage fees, credit cards, unpaid child support, and lawsuit judgments, etc. For a business this may include loans, wages payable accounts payable, rent obligations, and other operating expenses. When a business owner passes away, outstanding debt can be handled in many ways, so talk with your attorney about your situation.
Taxes must be paid from assets in the estate (including income tax, property tax, and possibly any estate tax). Be aware of liens, which may even exist before passing of the decedent; a lien is a legal right or claim against a property by a creditor. Liens are commonly placed against property so that creditors can collect what is owed to them. When an estate is insolvent, specific rules apply for the order in remunerating any claims on the estate from available funds. Also, any estate subject to probate falls under state law for payment of all debt. Again, your estate planning attorney should guide you through this process in order to be fully compliant.
It should be apparent that while cash income may cease or diminish upon second-to-die, the financial obligations of the estate continue to be immediate (i.e., lenders and other creditors expect timely payment) no matter the status of settling an estate. So, it is important to have cash readily available to pay bills; don’t expect immediate access to life insurance proceeds or sale of real property in order to meet the trust’s debt repayment needs.
Loans fall into two debt categories: secured or unsecured. Secured debt is backed by collateral in the event that the debtor cannot pay their debt, such as a house and mortgage. For example, it the trustor dies with a mortgage, the remaining payments must be done regularly or the lender foreclose on that collateral to pay off the remaining amount. Routinely, mortgages are paid off when properties are sold or by converting other estate assets to cash. What happens if you have an adult child living at your house? The inheritor would need to qualify for a mortgage on their own, or the home would need to be sold, or other liquid assets in the estate would need to be used to pay off the debt. If that is unfeasible, solutions might include a revocable trust or a qualified personal residence trust (QPRT). Talk with your attorney about the limitations and pros/cons of each option.
Unsecured debt is not backed by collateral but is still due on a timely basis, such as personal loans. Certain liabilities, such as utility bills, will need to be kept current until the estate closes. Other unsecured debt such as personal loans can wait a short time until the trustee accounts for all liabilities.
In terms of estate planning, consider all the above and also evaluate any loan encumberments for assets to be distributed. For example, if you gift a car to a grandchild but it has payments left on it, the beneficiary may not be able to make the payments, so consider paying off all remaining debt for that asset as part of the gift.
Fairness in Distribution
If you want equal distribution and are planning on designating specific assets to individuals, in particular real property, it is advisable to plan for the net value after debt payment and taxes.
Mortgages are often overlooked when splitting up assets, in part because trustors think this debt will be paid off by the time they die, or they simply fail to think of the net value of an asset (after deduction of any debt).
Please note that real estate holdings are a complex area that involve many considerations, including income potential, tax and valuation, so consult legal counsel.
State law also applies to creditors’ rights for their claims. There are methods to protect assets from claims of creditors in an estate, and ways of shifting the risk of unexpected death. Trustees should Inform their estate planning attorney of existing or potential debts owed, and estate plans should include how the trustee will handle paying off creditors.
Specialized Estate Planning Expertise
At Mortensen & Reinheimer, PC we have the experience and dedication to craft a personalized, creative estate plan with you. If you need an expert in developing an estate plan, please contact Mortensen & Reinheimer, PC at (714) 384-6053 to make an appointment, or use our online contact form. Our website is http://www.ocestateplanning.net.