Probate and Retirement Accounts and Insurance Policies

Dear Len & Rosie,

My sister recently passed away. She did not leave a will, but she did have a pension of about $250,000 of which her sons are the beneficiaries. Her $200,000 insurance policy was left to me to pay off her son's student loans, and the rest was to be distributed to myself and her grandchildren, nieces and nephews. She also left a credit card debt of $25,000. Does her pension or insurance qualify for probate? Are we responsible for paying off this debt? What options are available to us? Morally we feel responsible to pay the debt, is there a legal responsibility?

Patricia

Dear Patricia,

If your sister owned a home or other assets in her own name or within a revocable trust, then these assets are fully subject to the claims of her creditors, and her credit card debt would be paid off.

But retirement accounts and life insurance policies are different. They are not subject to probate as long as there are designated pay-on-death beneficiaries and they are not subject to the creditor claims  of a decedent except for federal estate tax. That's shouldn't be a problem because the estate tax exemption is now $5,250,000. Retirement accounts and life insurance policies with named beneficiaries are also exempt from Medi-Cal Estate Recovery Claims against the assets of persons who received Medi-Cal benefits during their lifetimes.

Do not use the life insurance money to pay off your sister's credit cards. Doing so would be throwing away money your sister left to the family. You're better off using the money to pay off your nephew's student loan debt, especially as student loan debt never goes away and in most cases cannot be discharged in bankruptcy. Honor your sister's wishes and divide up what's left the way she wanted.

Make sure that your nephews also understand that they shouldn't use their mother's retirement account to pay off her debts either. What they should do is to roll over their mother's retirement account into Inherited IRA's.  The rule used to be that any non-IRA retirement accounts had to be cashed in within five years of the participant's date of death. Fortunately the Pension Protection Act, enacted into law on August 17, 2006, allows retirement account beneficiaries to roll over any retirement account into an Inherited IRA. Your nephews should absolutely do this.

With Inherited IRA's, your nephews will have to take Required Minimum Distributions ("RMD") each year after their mother's death. The amount of each distribution is based on each beneficiary's age. Your nephews may also take out additional amounts, with no penalty, but all Inherited IRA distributions are subject to income tax unless they were rolled over from a Roth IRA or Roth 401k. The power of an Inherited IRA is that your nephews will be able to control when they pay the income tax due as the accounts are distributed. Instead of paying the income tax all at once, they may stretch out distributions over their own lives.

Len & Rosie