If you’ve been paying attention to the news, you know that student loans are bigger and more common than ever before. There is currently over $1.45 trillion in outstanding student loan debt in the United States, and 42 million Americans have some amount of student loan debt (the average borrower owes over $30,000). Despite student loans being incredibly common, there is still a lot student loan borrowers don’t know about their debts.
One in three consumers over the age of 40 are still paying on their student loans. Are you one of them? If you are, you may have questions about how to think about your student debt in the context of your collected wealth. Most importantly, what happens to student debt after you pass?
Student loans are issued either by the federal government or a private lender, like a bank. Depending on which kind of student loan you have, there will be a different impact on your loved ones when you pass.
If you have federal student loans, the news is generally pretty good. Federal student loans are forgiven when the student borrower dies, so there will be no impact on your estate or any inheritance you wish to pass on to your loved ones. The executor of your estate or another loved one will simply need to provide a copy of the death certificate to your loan servicer, and the debt will be forgiven without any tax penalty.
Federal Parent PLUS loans, which are taken out by parents on behalf of their children, are forgiven on the death of the student for whom the loan was issued or the parent who signed for the loan. However, there may be some tax implications. The parent whose child dies before a Parent PLUS loan is repaid will receive a form 1099-C when the debt is discharged. The amount of the discharged debt will be considered taxable income to the parent. Depending on the balance due on the debt, this can cause a significant tax liability for the parent.
While federal loans all contain some protections for student borrowers in their terms, private loans are mixed. Some private lenders may also offer a death discharge if the student borrower dies. However, more commonly the lender will treat the debt like any other and go after the balance when the student borrower dies.
When private lenders issue student loans, they sometimes will require a cosigner to guarantee the loan. If a private student loan has a cosigner, this adds another layer of complexity. A cosigner is equally responsible for student loan liability as the student borrower, so he or she will remain liable for the balance of the loan if the student passes away before it is paid off. Some lenders may even consider the student’s death a “default” and bring the entire balance of the debt to come due immediately.
To avoid these consequences, it is a good idea to see if your lender will allow you to apply for a cosigner release. Lenders will sometimes allow a cosigner to be released from liability if a certain amount of the debt has been paid off and the borrower can show a consistent payment history.
Probate is the process by which a state court will assess the validity of your will, name an executor, pay debts, and then distribute the remaining assets in accordance with your will.
One of the first duties of an executor is to assess any debts owed and assets held by the estate to determine if it is solvent or insolvent. A solvent estate is one that has enough assets to pay off all outstanding debts. An insolvent estate owes more than it holds.
Even if an estate is solvent, creditors are paid before any remainder is distributed according to the will. For heirs, this may mean that their inheritance is significantly (or entirely) reduced by the time all debts have been satisfied.
The probate process is completed once all outstanding liabilities are satisfied and the remainder of the estate (if any) is distributed to the decedent’s heirs.
One way to prevent your private student loan debt from impacting the inheritance you leave for your loved ones is to take out a life insurance policy in the amount of the balance owed. This would provide enough funds for your loved ones and heirs to immediately pay back the balance owed on your student debt and keep your estate solvent.
Another way to ensure that your loved ones will receive a portion of your wealth after you pass is to keep as many of your assets as possible out of probate. This can be done by naming beneficiaries on all financial accounts, retirement accounts, and insurance policies. Beneficiary designation forms supersede anything written in a will, so these accounts will pass directly to your named beneficiary without passing through probate. If you name your estate or someone who has deceased as your beneficiary, however, the assets from these accounts may revert to your estate and be included in the probate process.
Another way to keep assets out of probate is to place them into a trust. Assets owned by a trust can only be distributed to the named beneficiaries under the guidelines of the trust. Creating a trust to distribute assets to your heirs will protect your wealth from creditors, including private student loan holders. An estate planning attorney can advise you on the best ways to use trusts to ensure your loved ones are cared for after you pass – even if you still have outstanding student loan debt.
Talking to your children about money – especially about debt – can be awkward, but it is absolutely necessary. Not only will your children be able to learn from your experiences, but it is important for your estate planning strategy to understand your children’s liabilities. If your child has significant student loan debt, difficulty repaying student loan debt, or is in default on student loans, you will want to take steps to minimize the chance your estate will end up with creditors, rather than with your heir.
If you leave any assets to a child who has defaulted on student loans, these assets will be vulnerable to collection efforts. Student loan debts do not go away (even in bankruptcy), so if your child defaulted on his or her student loans years ago, any gift or inheritance he or she receives may be at risk.
One way to protect your child’s inheritance is to place assets into a trust. A trust can help ensure that your estate is passed on and used according to your wishes. Establishing a trust and protecting the assets from a beneficiary’s creditors is technical, but it is both possible and legal. As the grantor, you can limit when and how funds are distributed to beneficiaries and specify the ways in which you want the funds to be used. Because the funds have limited use, creditors would not be able to seize these assets to pay back a loan in default.
If you are not sure you need an attorney, you can always come in for a consultation to discuss your situation. Please contact our office if you or your loved ones are concerned about student debt. We are happy to talk through your loans with you and come up with a solution that protects your loved ones.
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