Settling Trust Debts Before Distributing Assets

Creating a living trust is an excellent way to avoid having assets pass through probate courts and create showdowns for potentially messy challenges brought by individuals claiming to be “interested parties” to the estate. However, even living trusts must still settle up on certain types of debts incurred against the estate by the deceased. If you or a close friend or family member are named as a trustee, you should take some time to understand the estate laws governing these and other estate concerns.


First, it is important to know that not all debts expire upon the passing of the trust’s creator. For example, federal student loans are discharged upon the debtor’s passing but private student loans may not be vacated. Furthermore, debts held by two or more persons may not be discharged and the surviving debtor may carry the remainder of the responsibility.


Second, unlike estates handled by a last will and testament, public notices to creditors are not posted in the media. Again, this is because the estate does not pass through probate court. Instead, the trustee will need to contact known creditors and inform these entities of the trust maker’s passing. By informing known creditors right away, these entities only have a limited time to recover debts from the estate and the debt may be discharged should these creditors fail to act in a timely manner.


Additionally, certain assets like pensions, insurance policies, and a 401(k) cannot be touched by creditors if an individual is named to the policy. However, if the policy is named only to the estate, creditors may still be able to target these types of assets to recover the debt.


How do I pay debts to a trust?


It is the trustee’s duty to take stock of all the estate’s assets and debts in order to settle liens and disburse assets to beneficiaries. It is very important to note that if the trustee does not settle up with creditors to the estate, these entities may be able to file suit against the trustee and the beneficiary to recover the debt. Furthermore, if the creditor sues only the beneficiary, the beneficiary may in turn sue the trustee to indemnify himself or herself against the suit.


Debts against an estate handled by a trust are usually paid out with liquidated assets like bank accounts and other monetary assets. Should cash assets be insufficient to cover debts, assets like real estate may need to be liquidated to raise the necessary funds to settle debts. If after all the assets of an estate have been liquidated to pay out creditors in priority cited under state law, then beneficiaries and remaining creditors may be left with nothing in the end.

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