When you pass away, the tax man isn't the only one who can take a bite out of the assets that you leave behind for your loved ones.
Whether it is cash, real estate, retirement money or other funds, inherited assets can suddenly come up for grabs in a number of scenarios when creditors and others come calling.
Experts say you can often make your estate creditor-proof by avoiding probate, which is designed to pay off creditors. Here's a primer on four ways to avoid probate and prevent outsiders from snatching the money you've left for your heirs. These measures protect your relatives if they ever get sued, file for bankruptcy or go through a nasty divorce after you've died.
1. Create a trust
Establishing a trust is not only a key way to skip probate court, it can also prevent the assets you've spent a lifetime accumulating from going to predators who might slap your heirs with lawsuits.
Scenario: A 77-year-old man died of cancer. He had a will that left $250,000 to his 26-year-old granddaughter, whom he intended to help buy her first home. Two years after her grandfather's death, the granddaughter got into a minor car accident. The other driver wasn't hurt but sued anyway, eventually winning a big chunk of the young woman's $250,000 inheritance.
How to prevent this: Establish a trust instead of passing money via a will, recommends Elise Gross, an attorney with the Presser Law Firm P.A., a Boca Raton, Fla.-based company that operates nationwide.
What About Debt?
Q: While it's great to plan for the assets you'll pass along, what about debts you might have upon death? Can creditors go after your family members and make them pay those bills?
A: It depends. Secured obligations, such as a mortgage, do have to be paid off. But your relatives aren't legally responsible for unsecured debts such as credit card bills. "If Dad is the only one on a credit card, Mom doesn't have to pay it," says Michigan attorney Pat Simasko. "Kids also don't have to pay a parent's unsecured debts" if the parent dies, he adds.
"The trust can specify that the money only be used for certain purposes, like the education, care or support of a specific beneficiary. This way, there can be no payout to creditors," Gross says.
In some states, such as Florida, living trusts are commonly used. These trusts are called "revocable" because you control them and can change them at any time while you are alive. Once you die, however, your living trust becomes irrevocable (since you aren't alive to revoke it), and the trust is a separate legal entity.
In New York and New Jersey, people typically create testamentary trusts, Gross says. This type of trust is created by the terms of a will, and the trust only takes effect upon a person's death.
Both types of trusts can contain specific language and provisions that prevent your beneficiaries' creditors from seizing any trust assets.
Unlike wills, "trusts are not a matter of public record. They're a tool for maintaining privacy," says Reid Abedeen, a partner at Safeguard Investment Advisory Group LLC. "In addition, trusts are much more difficult to contest than a will."