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How does my student loan effect my estate plan?

Saddled with six-figure debt? As a college degree becomes increasingly necessary to succeed and tuition continues to rise, you are definitely not alone. Financial planning is generally harder when dealing with constant student loan payments, but the presence of debt doesn’t mean that long-term estate planning is unimportant or impossible. In fact, student debt makes it even more vital that you have a will in place to deal with an (often more complicated) set of debts and assets.

That being said, the first question is: what happens to your loans when you die? As you know, there are two types of loans, federal and private, which are dealt with very differently. Federal student loans will be discharged upon death - the process is not automatic, and someone will have to request loan relief from the appropriate agency, but loan forgiveness from federal lenders is guaranteed. All of that is relatively easy, the catch is that this creates a “discharge of indebtedness income” or “cancellation of debt (COD) income” which is a type of income recognized and taxed by the IRS. This means that even when a loan is forgiven, the estate will be forced to pay tax on the addition “income” that is the forgiveness of the loan.  It is important to take this into account when estate planning, as often someone with student loan debt will leave this tax debt to their estate, and depending on the size of the loan and the borrower’s income bracket, it can be a substantial chunk of money.  If assets are not allocated through a will to pay for these additional taxes, the distribution of the estate won’t follow the individual’s wishes and items might be sold off through abatement in a way that could have been avoided.

Private student loans create a whole different set of issues than public ones - private loans come from a large number of companies, each of which has a different policy regarding what happens when a borrower dies.  Some loan agreements have express conditions about what happens if a borrower dies, others do not, but different companies have different policy, and some companies do forgive debts in the case of death. Asking the loan company is the right first step. Some loan conditions are less forgiving and will include acceleration clauses that demand the entire balance of the loan be paid under certain conditions, including the death of the borrower. Even if the debt is forgiven, as mentioned before, the estate will still be liable for the tax on the discharge of indebtedness income. If there is a co-signer on the loan, such as a parent or spouse, that individual will be liable for the full balance of the loan, although lenders will probably attempt to collect as much as possible from the estate first.

It is important to plan around your loan debt to make sure that whatever happens, your wishes will be followed through, and that includes making sure your estate planning accounts for the effects of indebtedness after death. Make sure to check out the specific agreements in your student loan documents that spell out what will happen to the debts in the case of your death, and then allocate appropriate assets in your estate plan to pay off whatever debts remain ( whether that be the loan itself, or the  tax on the discharge of indebtedness income).

If you want help creating an estate plan that takes your student debt into account, and you reside in Montgomery, Philadelphia, or Delaware Counties, please contact us