If you’re like most executors, you’ve never done this before. You’ve been named to administer someone’s estate, but most of what you know about wills and estates comes from what you’ve seen on television and movies.
But is there really much to know? Don’t you just do what the will says and move on? Pray that some long-lost heir doesn’t show up to throw a wrench into everything?
Unfortunately, estates aren’t always that simple. (And fortunately, long-lost heirs rarely turn up.) There’s a priority to how the funds from an estate are used and distributed, and it’s based not only on the terms of the will but also on state law.
Here’s what you need to know about who gets paid first from an estate.
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Probate laws determine priority
Many of us think of the will as the deciding factor in who gets what after someone dies. But whether a person dies with a will or without one, a state’s probate laws dictate the order of payments.
But isn’t probate all about doing what the will says?
Probate is the process of distributing the assets, paying off the debts, and finalizing the affairs of someone who has died. While a will may specify who inherits the value of the estate or particular assets, the will almost never discusses the specifics of how an executor will pay off debts, cover funeral costs, or pay taxes.
To ensure that important debts and taxes do get paid, state probate laws define exactly which payments get made first. That way, the executor doesn’t distribute funds to heirs and then runs out of money to pay creditors.
Note: If an estate doesn’t have to go through probate, either because it meets a state’s small estate exemption or because all the estate’s assets are non-probate assets (for instance, because they’re all in a trust), these payment priorities do not apply.
Debts before heirs
The most important thing to understand is that you must pay the estate’s debts before you distribute anything to the heirs.
And debt doesn’t just mean credit card bills or mortgage payments from before the deceased died. Debt also includes any money the estate owes currently. That includes funeral expenses (often reimbursed to a family member who covered the costs) and taxes and could include a family allowance.
What’s a family allowance? Well, some state laws allow a spouse and dependents of a deceased person to petition the court for a portion of the estate to be distributed to them during probate. These laws acknowledge that the deceased’s immediate family may have difficulty managing financially after losing the deceased’s income. In most states, the judge has discretion over whether to award a family allowance, and it’s important to note that any money provided to the family does reduce the overall value of the estate.
As with all aspects of probate, each state sets its own rules. But the general priority of payments from the estate flows like this:
Funeral costs. The estate must pay the costs of the funeral service and burial or cremation. States may cap these costs, though, so consider a possible cap before planning an expensive service.
Administrative costs. The estate is responsible for the costs associated with administering the estate — like court fees, legal fees, and payments to the executor.
Family allowance. In states where family allowances are authorized, they are generally given high priority.
Taxes. The estate must file the deceased’s final tax return and pay any owed income tax. The estate is also responsible for paying any property taxes and estate taxes required.
Medical bills. The costs of the deceased’s medical care are categorized separately from any other unsecured debts (like credit card loans) and are generally given a higher priority for payment.
All other debts. The executor is responsible for notifying creditors of the deceased’s death, and they generally have between three and six months to make a claim. The executor is not responsible to personally pay any of the estate’s debts unless they were a co-signer or joint owner.
Note that one common type of debt is treated differently — mortgage debt (and other liens on real property).
Because of the contractual nature of a mortgage, the mortgage company has the right to foreclose on the property and essentially bypass probate to recover assets.
What does that mean? Well, in practice a mortgage company becomes the #1 entity to get paid because they have the option to foreclose if the payments are not made. If the home is sold, the mortgage company is paid at closing, and the remaining proceeds go to the estate.
The estate is responsible for paying its debts even if it has to liquidate assets to do so. That might mean selling jewelry, stocks, a house (unless a homestead), or vehicles — these are considered non-exempt assets. In general, the only types of assets that can’t be liquidated to pay debts are retirement accounts and life insurance policies. These are considered exempt assets.
But what happens if the estate doesn’t have enough money to pay all these debts? Good question.
When the estate doesn’t have enough money to pay debts
Sometimes a person dies with more debt than assets. In that case, their estate is considered insolvent. If their loved ones were expecting an inheritance, the truth can be painful. No heirs will receive a distribution from the estate because their claim to inheritance has a lower priority than the claims of creditors. Every state’s probate laws agree on this point. Even if an estate is insolvent, the executor may still be allowed or required to set aside an allowance or a homestead for a surviving spouse or dependent children, depending on state law.
The executor must sell off all non-exempt assets of the estate to pay the debts in the priority determined by state law (like the one listed above). There could be many creditors in that last category (all other debts, above) requesting payment. Creditor claims will likely be paid in chronological order based on when they made the claim (or the last in priority may each receive a prorated amount), so some creditors will be out of luck.
Here’s an important thing to remember: in the majority of circumstances, family members are not responsible for the debts of the estate. If debt collectors are contacting you to make payments on the deceased’s bills, you may want to seek legal advice. Unless you were a co-signer or joint owner of a property with a debt attached to it, you’re probably not legally responsible for the debt.
However, one word of caution: if the executor or administrator pays out from the estate in the incorrect order, they can be held personally responsible for debts. In these circumstances it is highly advisable to seek legal counsel and ensure you’re making payments in the proper order.
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