A living trust is created while the person who created the trust was alive. The trust allows the trust creator to hold property for the benefit of one or more people. Upon the death of the trust creator, the property held in trust is distributed to those people specified in the trust document, who are called beneficiaries. Before the trust property is distributed, however, any remaining debts the trust creator had must be paid. Failing to pay these debts can result in serious consequences.
Debts that Survive Death
Not all debts must be paid before the trust property is distributed because not all type of debt survive the death of the person who owed the debt. The trustee should first determine the type of debt owed at the time of the debtor’s death, such as credit card and healthcare debts. The trustee should then contact the person or entity to whom the debt is owed to determine whether the debt survives the debtor’s death -- in other words, whether the debt must be paid. Student loans are a type of debt that often expires upon the debtor’s death, meaning they don’t have to be paid.
Trustee’s Responsibility for Paying Debts
The person in charge of a living trust is called the trustee. It is the trustee’s responsibility to distribute the property held in the trust to the beneficiaries listed in the trust document. Before the trustee can distribute the trust property, however, he must pay the debtor’s surviving debts. If the trustee fails to pay the debts before distributing the trust property, an unpaid creditor can sue the trustee or the beneficiary who received the trust property for the amount owed. If the creditor chooses to sue the beneficiary, the beneficiary can then sue the trustee for reimbursement if the creditor wins the lawsuit against the beneficiary. The trustee should determine whether the debtor had insurance that covers some or all of the debt. Health insurance, for example, may cover the majority of medical bills.
Generating the Necessary Funds
Unless the trustee of the trust was a co-signer on the loan, the trustee is not personally liable for the debts of the deceased debtor. Because the debt belongs to the debtor, the debt can be paid exclusively from the debtor’s property. Some assets, like a house or car, can be sold to generate the necessary cash. The trustee can also use money in a bank account or proceeds from a life insurance policy to pay the debts if those funds are held in the trust. In the event that there is not enough money to pay the debts, state law provides a list of creditors who are entitled to payment before other creditors. If there is not enough money to pay off all of the debtor’s surviving debts, the beneficiaries will receive nothing from the trust.
Probate as an Alternative
One of the advantages of creating a living trust is avoiding probate. Probate is a court process that handles the estate of a deceased person and distributes the person’s assets. As part of the probate process, the court oversees the payment of creditors. During probate, notices are sent to each of the debtor’s creditors. The creditors then have a limited amount of time in which to file a claim for repayment with the court. If a creditor does not file its claim in time, it forfeits the right to payment. Although probate is not required for a trust, the trustee can choose to file a probate case and let the court system handle the decedent’s creditors.
References & Resources
- The Executor’s Guide: Settling a Loved One’s Estate or Trust; Mary Randolph