What happens to your debt when you die?

The Probate Process

Although the probate process is defined by state laws, and thus varies greatly depending on where you live, there are a few commonalities that exist. These commonalities include the order by which your estate is paid out. Let's go back to Pappy's pocket watch. If your bank accounts and other assets cannot fully cover the debt you owe, is the pocket watch Pappy promised your grandson in jeopardy of being lost to a bank? Unfortunately, as part of the estate, family heirlooms are not safe from debt collectors. But that doesn't mean debts are paid out first. The probate process settles the estate in a responsible order, starting with funeral costs.

They say you can't take it with you when you die, but they failed to mention just how expensive dying can be. Not only are there funeral expenses to pay, there are lawyer and other administrative fees involved in settling an estate. The probate process assures all of these expenses are paid out first, so your family is not left with a stack of bills in your absence. If there is any money left over, we move on to step two: family allowances. Family allowances can be paid to the surviving spouse and/or minor children and are -- you guessed it -- defined by state laws. These can range from a do-not-exceed amount, such as Kansas's cap of $25,000 to an open-ended amount that takes into account the family's need and provides enough money for one year, as is the case in Texas [source: Kansas Bar Association, Texas Legal Services Center]. After family allowances, we move on to debt. And again, here's the kicker -- only after all debts have been paid do we move on to division of the estate to surviving family according to a will, or in its absence, state law. If the estate's value cannot pay out all of the debts, anything with value that was bequeathed in the will must be sold to cover the debt.

Now that we understand what commonalities exist, let's discuss the exceptions. We know how an estate is settled, allowing some money for expenses and surviving family before paying out debt, but what about life insurance policies and 401ks? How are mortgages handled? We'll discuss these and other issues that muddy the waters on the next page.