Creditors and IRAs and 401(k)s After Death

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When someone dies leaving an IRA or 401(k), the money might be use to pay their final bills under some circumstances. It depends on whether the account has a designated beneficiary other than the decedent's estate at the time of death. An IRA or 401(k) has a designated beneficiary if the decedent completed a beneficiary designation form for the account prior to their death. 

Debts Are Paid in Probate

Debts don't simply go away when the individual who has incurred them dies. Responsibility for payment typically passes to the deceased's probate estate. The executor of the estate uses any cash left by the decedent, as well as liquidated assets, to pay off these creditors.

Most states require that the executor send written notice to all known creditors to alert them to the death and to inform them as to what they must do to make claims to the estate for the money they're owed. Executors must additionally print notice in a newspaper for creditors they might not know about.

Exceptions exist for debts on which someone who's still living has cosigned for the obligation, and in community property states where debts incurred during marriage are treated as the equal obligation of both spouses. Responsibility for paying the debts would transfer to the living borrower, not to the decedent's estate, in these cases.

The Surviving Designated Beneficiary

The retirement account will pass directly to its designated beneficiary outside of probate if the beneficiary survives the decedent. The account will avoid the reach of the decedent's creditors because the probate process uses estate assets to pay off the decedent's final debts. The IRA or 401(k) can't be used to pay the decedent's final bills if it doesn't become part of the estate.

There's No Surviving Designated Beneficiary

One of two things can happen if the decedent completed a beneficiary designation form prior to death, but the named beneficiary predeceases them.

  • The IRA or 401(k) account will pass into the decedent's probate estate and become available to pay the decedent's final bills, or
  • The IRA or 401(k) will pass directly to the decedent's heirs-at-law outside probate pursuant to the terms of the IRA or 401(k) custodian's payment policies. The IRA or 401(k) won't be used to pay the decedent's final bills if this happens.

Heirs-at-law are individuals who are so closely related to the decedent that they would be entitled to inherit from them in the absence of a will.

When No Beneficiary Is Designated

The same two scenarios can happen if the decedent failed to complete a beneficiary designation form before their death. Either the IRA or 401(k) will pass into the decedent's probate estate and be available for paying the decedent's final bills, or the IRA or 401(k) will pass directly to the decedent's heirs-at-law, safe from the hands of creditors, depending on the custodian's policy.

When the Decedent's Estate Is the Beneficiary

The retirement accounts would go into the decedent's estate for eventual transfer to their estate's beneficiaries, those named in the will to receive the decedent's property, if the estate is named as beneficiary. But these beneficiaries can only inherit what's left over after the decedent's final bills, taxes, and expenses of operating the estate are paid.

The retirement funds would be used to pay these bills and expenses unless the estate contains adequate cash to otherwise satisfy the debts. This might be the case if the deceased had a life insurance policy with proceeds payable to their estate for this purpose.

Some complicated tax laws pertain to inherited ERISA-qualified retirement assets, so it's likely that the executor or personal representative of the estate would first sell other property if estate assets must be liquidated to meet creditor obligations. 

NOTE: Laws can change frequently, and this information might not reflect recent changes. Please consult with an attorney for current legal advice. The information contained in this article is not legal advice and is not a substitute for legal advice.

Article Sources

  1. Federal Trade Commission. "Debts and Deceased Relatives." Accessed Oct. 13, 2020.

  2. Hanscom Federal Credit Union. "Here's The Difference Between An Heir And A Beneficiary." Accessed Oct. 13, 2020.

  3. HG.org Legal Resources. "What Happens to an IRA With No Beneficiary Designation?" Accessed Oct. 13, 2020.